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Senator McCain: Keep taxes low, cut spending, create jobs with alternative energy, including nuclear power plants, including drilling offshore, wind, tide, solar. Free us from our sending $700 billion or whatever it is across to countries that don't like us very much. Free up credit. Larry, I’ve been meeting with a lot of small businesspeople, and they're having great difficulty getting lines of credit. This is something we've got to free up. Now, we have given the banking, the banks and other institutions the kind of infusion they need. It's time they pass that on to small businesses who say they can hire. They've got business, but they just haven't got the line of credit.

But make sure that everybody knows that we're going to keep taxes low. We're not going to raise taxes. We're the creator of business and the engine of our economy and small business, Senator Obama's proposal would tax half of all small business income, some 16 million jobs in America would be at risk. And then you put on top of that, he will force his mandated health care plan on small businesses, their employees, and their children. It's not good for America.

Kudlow: Just on the credit piece that you mentioned a few moments ago, have you and your campaign been following the improvement in the Libor credit market in London and the commercial credit markets here in New York? It looks like the Treasury plan is beginning to work. That may be a positive sign. Do you follow those areas?

McCain: Yeah, I do, and I get updates all the time. One of the areas that I’m still very disappointed in, though, Larry, and you may not agree with me, we've got to go in and get these home mortgages bought and give people mortgages they can afford so they can stay in their home. Look, I’m in Ohio. Homes are being foreclosed everywhere. A lot of these people, it's their primary residence, could stay in their home if they had a new mortgage at the new value of their home, at payment levels they could afford. That is the slow -- one of the slowest parts. I think it's the slowest part right now. Keep people in their homes. If they can't realize the American dream and stay in their homes, then obviously, the rest of this equation is hard to complete.

Kudlow: Let me swing back to the investor side. There are about 100 million investors, according to the Federal Reserve survey. And interestingly, in recent national elections, they're a huge voting block, almost two of every three votes cast are cast by people that own stocks either directly or indirectly. And yet, sir, you very, very seldom mention investors on the campaign trail. Why is this?

McCain: Well, I try to talk about them more often. A lot of the people that come, frankly, are people that are having trouble staying in their homes, keeping their jobs, et cetera. But I think it goes back to all this business of Senator Obama's view of "fairness." When Charlie Gibson said, why would you want to raise capital gains taxes when you know it will decrease revenue? And he said in “fairness”. And he told Joe the Plumber -- Joe the Plumber got the message through better, what we've been trying to do this whole campaign. [Obama] wants to "spread the wealth around." That takes from the investor class. That takes money from one group of Americans and gives it to another.

Now that signal has been very clear. And I think people ought to pay attention to it, because it's been tried before in other countries, and policies of other left, liberal administrations. It doesn't work, and it's bad for America. We want to encourage the investor class, and that means capital gains and dividend taxes are low.

Kudlow: You've just unveiled a new tax cut on capital gains. Can you tell us about that? Because in some sense, that's probably the most important investor class tax.

McCain: It's the most important in many respects, Larry, and we want it low and we want it lowered. Every time -- there's one tax that there's no argument about, that every time it's been lowered since Jack Kennedy, we have seen an increase in revenues. Now, why anybody would argue, as Senator Obama does, that we need to raise it, even if it's -- of course, the amount needed to raise it is varied with whatever poll he's taken, but the point is that we want to lower it and keep it low and encourage investment, especially now in America in these difficult times.

Kudlow: But Senator, what is -- the current law rate is 15%.

McCain: Yeah, yeah.

Kudlow: You're taking the cap gains rate down to what?

McCain: First down to 10%, I would like to see it, and gradually even make it lower. Look, why should we tax people's gains twice? Why should we tax them twice, okay? They make an investment, they should be able to get their returns on their investment. And capital gains is obviously -- low capital gains tax is probably the greatest incentive for investment that we have in America today. And so, look, I’ll be glad to listen to smart people like you, Larry, but the worst thing we can do is tell people we're going to raise it, and that, obviously, would chill investment in America, right?

Kudlow: Well, with your lower capital gains tax, which in a recent speech you said 7.5% for two years, are you surprised, though, that respected pollsters like Scott Rasmussen or Investors Business Daily are still showing you running neck and neck, even with Mr. Obama? Back in 2004, President Bush beat John Kerry by 11 percentage points among investors. Now, you've got a lower cap gains tax. Mr. Obama proposes to raise the cap gains tax from 15% to 20%. Except you're still running even in the polls. Can a Republican win running even among investors? And why don't you think your message on capital gains has resonated with a bigger margin among investors?

McCain: I'm not sure, except obviously, when he broke his word that he would take public financing if I also did, he signed a piece of paper, that obviously, he's had a huge money investment. Look, I’m a 7.5%, I’d like to keep it permanently at 7.5%. Right now, we need more investment in America and in the stock market and in businesses and investment than ever before in these difficult times. So, it's pretty clear that if we keep them low, we will provide another tool for encouraging investment. Look, we are -- I am so happy we are where we are. I see a level of enthusiasm out here in this campaign, Larry, that is remarkable. I haven't seen this level of enthusiasm before. I'm very optimistic, and we're coming from behind. I'm the underdog. That's where we always like to be. But we are within margin, and I’m very happy where we are.

Kudlow: Another really important tax for the stock market investors, of course, is corporate profits. Profits are the mother's milk of stocks, as I have said from time to time. You've proposed to lower that from 35% to 25%. Senator Obama says the other day, that's merely another huge and permanent tax cut for corporations, including $4 billion dollars for the big oil companies, but it is no help for workers. Would you react to Mr. Obama's criticism of your corporate tax cut?

McCain: He doesn't get it. Corporate tax rates in America are the second highest in the world. Japan is only higher. Ireland has 11%. Business -- I like to call them business taxes, because that's what they really are, because they're businesses and they create jobs and they create employment. And when businesses can go anyplace in the world, where are they going to go? Look, I can name you Fred Smith of FedEx, Meg Whitman, other CEOs who will tell you, when they have a choice to go around the world and pay less in taxes where they can invest more and increase businesses and jobs, they're going to do that.

Obviously, they want to stay in America. And they want to create jobs in America, and they will, but we want to give them the incentive to do so. And lowering the business tax, the corporate taxes, in my view, they should be lower than 25%. Why is it that we're the second highest in the world, when 20 or 30 years ago, we were amongst the lowest in the world? It's not an incentive to businesses and jobs in America. It shows, frankly, that Senator Obama just doesn't get it.

Kudlow: You said yesterday or the day before when you were in Miami, Florida, the Democratic Congress is going to remove tax incentives or tax preferences for 401(k) accounts. Of course, that is a huge investor issue. What did you mean by that? What is the plan that Democrats want to take away from 401(k)s?

McCain: Well, that's exactly what they're saying. And Barney Frank, who is powerful, chairman of a powerful committee in the House, said we're going to raise taxes and we're going to increase spending. That's exactly the wrong thing to do in the economic difficulties we have. How did we get into this ditch? We ran up a $10 trillion deficit on our kids and half a billion dollar debt to China. So, obviously, they want to take the 401(k)s and use that money to give that to the government to spend, rather than people, and I think that's very dangerous disincentives to savings, which is exactly the cause of one of our problems, as we all know.

Kudlow: Last one, Senator, and I appreciate your time very much. Americans have an innate sense of optimism and confidence about stocks and the economy. The Rasmussen poll shows 73% believe stocks will be much higher five years from now than they are today. Is there a way for you in the closing days of this campaign to appeal to the innate sense of optimism that Americans have? Is there a way for you to connect with the investor class?

McCain: Well, I hope we've connected with the investor class by them examining our plans as we come closer to the election. But I also have to tell you, Larry, the people who want to invest are Joe the Plumbers of this world who want to own their small business. They want to employ people, and they want to invest in their futures and in the stock market and make investments, 401(k)s, IRAs and others, so that they could ensure their retirement and their future. And Joe the Plumber was able to do something that we hadn't been able to do this whole campaign, and that is articulate the reason why he doesn't want to see his taxes raised so that he can use it to buy a business and create jobs and to take care of his and his family's future. That's what this campaign is boiling down to, and that's why we're getting closer and closer, my friend.

Kudlow: All right, Senator McCain, thank you ever so much for sharing your time. Good luck in the rest of the campaign, sir.

History is repeating itself with accelerating fury.

Mounting a broad assault on the free market legacies of Ronald Reagan and Margaret Thatcher, Mr. Soros summarized his historical arguments in terms ready-made for any public school educated voter. "Markets left to their own devices created one crisis after another. Each time the regulators intervened and solved the problem. Periodic financial crises served as successful tests of the misconception of market fundamentalism.”

Laying the blame for the current meltdown squarely on the loose monetary policies of Alan Greenspan, abetted by the securitization of mortgages and various synthetic instruments that didn't take into account their own influence on housing prices, Mr. Soros managed to opine for over an hour without once mentioning the role played by Government Sponsored Entities (GSEs) like Fannie Mae and Freddie Mac. How massive injections of fiat currency feeding an insatiable demand for mountains of risky mortgages by politically-driven and taxpayer guaranteed GSEs qualifies as “markets left to their own devices” was left as a mystery for the listener. Ditto for role the FDIC played with its ill-conceived and poorly implemented bank deposit insurance program that unleashed the Savings and Loan debacle, another supposed example of the failure of capitalism.

Calling for “forcefully changing the terms of contracts ex post facto” by resetting the principal value of mortgages to 80% of a home’s current market value, Mr. Soros noted that “there is one small problem.” No, it’s not the challenge of determining what the “fair” value of a particular home might be when negotiating with a counterparty wielding a gun. The small problem, Mr. Soros laments, is that “this is actually unconstitutional.” He went on to conclude with unconcealed glee that “it needs to be done and it can be done, but it’s going to be very difficult.”

Surmounting constitutional constraints may be easier than Mr. Soros thinks. The process has already started with nary a whimper from either political party as the questionable bailout programs recently rushed through Congress metastasize beyond recognition. Banks that have been recapitalized with taxpayer money to cover up bad loans are now being strong armed to give out – more bad loans. A bubble fueled by runaway money creation is going to be fixed with – more runaway money creation. The same foxes in Congress who were guarding the Fannie and Freddie henhouse are being touted by their media enablers as the saviors of our economy. Get ready for a series of hearings and show trials designed to cow the innocent along with the guilty across corporate America, sure to be a ratings hit. This runaway train can only accelerate once the entire apparatus of government gets turned over to unchecked single party control a few months from now.

It is perhaps not remarkable that every major crisis throughout our nation’s history, whether financial or military, has been met with calls to trample the Constitution. And in large measure this is exactly what has happened as each generation forgets that the prior constraints ever existed.

If our democracy ultimately dies by its own hand leaving us yearning for a strong man to save us from the howling mob - the fate of every democracy in history – the deathblow can only come from one source. No external enemy can possibly match the destruction unleashed by the erosion of the checks and balances our founders wisely gave us to protect us from ourselves.

McMahon estimates that McCain’s tax plans would be a modest win for New York, allowing its citizens to keep about $1 billion of income in the next two years that they might otherwise send to Washington. Those gains would come largely because of the impact of his plan to increase the exemption that married couples earn for each dependent to $7,000, from $3000.

This would be in addition to the impact of the tax cuts of 2001 and 2003, which proved a huge boon for New York. According to McMahon’s study, by 2004, when the full effect of those tax cuts were in place, New Yorkers were saving nearly $14 billion a year in federal income taxes, boosting after-tax income of the state’s residents by 2.7 percent on average. As that great New Yorker Damon Runyon might have put it, that’s a lot of cucumbers.

Obama’s plan would have quite a different effect, largely because it would roll back the tax cuts of 2001 and 2003 on the top tax brackets and raise capital gains and dividend tax rates for those earners. While Obama would also cut taxes for lower income households, largely through a series of tax credits, those reductions wouldn’t be enough to offset the tax increases, so that New Yorkers would probably send about $3 billion more to Washington in the next two years than if the tax code were left unchanged. All told, the difference in the two tax plans represents a swing of $4 billion for the New York State economy.

The impact wouldn’t be limited to individuals, however. Obviously, taking money out of a private economy also influences state and local tax collections. McMahon’s study estimates that the net reduction in taxable income among New Yorkers under Obama’s plan would cut state taxes by about $800 million over two years, and New York City tax collections by $144 million. Considering that New York State has a projected two-year budget deficit of $14 billion, I supposed that the $800 million wouldn’t qualify as much more than a little bit of loose scratch, as Runyon would have described it.

Obviously, there are a lot of variables that could change these figures including the rapidly slowing economy, where incomes and investment portfolios are changing so quickly that many of us may be sending less to Washington no matter who’s in charge.

Still, it’s a pretty good bet that changes in tax policy would have roughly the kind of impacts outlined in McMahon’s study, and obviously not just for New York. Other states with higher-than average incomes and with concentrations of high-income earners would be similarly affected, most especially Connecticut, New Jersey, Maryland, Massachusetts, Rhode Island, Maryland, New Hampshire, New York, and California. My handy online RealClearPolitics electoral map tells me each of those states will go fairly easily for Obama. This shouldn’t be surprising. Each of those states voted for John Kerry in 2004 even though they probably all realized a big benefit from the Bush tax cuts.

There are several explanations for this. An obvious one is that although these states have more higher-income earners than the country in general, those who might benefit from an Obama tax plan still outnumber those likely to pay his tax increases.

But that doesn’t completely explain the electoral map. There’s something else going on, as Columbia University political scientist and statistician Andrew Gelman notes in his new book Red State, Blue State, Rich State, Poor State. Gelman observes that while lower-income voters are more likely to vote Democratic everywhere, voters in moderate and high income households are more likely to vote Republican in red, or conservative states, and equally as likely to vote Democratic as Republican in blue, or liberal, states. What accounts for this? Looking at the differences among wealthier voters in these states, Gelman finds one distinction that is compelling to him: In blue states, wealthier voters tend to be more secular, and in red states they are more likely to be religious. Simply put, many higher-income citizens may be voting according to their cultural or religious values, not their pocketbooks.

Of course, just because people vote their cultural values doesn’t mean they don’t act in their own economic interest. If Obama does raise taxes on high income earners it is almost certain, based on prior tax increases, that some of those affected would do what they can to minimize the additional tax bite. One common strategy is to load up on tax-free investments, for instance. It’s no coincidence that New York City is one of the largest issuers of triple-tax free muni bonds in the country. The city’s high-earners have a big incentive to shelter income by snapping up munis, and they do so in record numbers regardless of how they vote.

Another strategy is to become less productive, something that’s easy for most high-income families to do by simply working less. According to Census figures, 76 percent of all families in the top income quintile contain at least two adults working full time—more than in any other income quintile (this is actually how people become rich in America today). In some of these families with children it will make more economic sense for one parent to stay home with the kids and save money on day-care than subject a family’s second income to a 45 percent-to-50 percent combined federal, state and local tax bite. You can’t argue with those family values.

Of course, Obama’s supporters in blue states, which include most of the major political figures in these places, will argue that his presidency will redress the flow of tax dollars to Washington through policies that send more federal spending their way. But don’t believe for a moment that this will make a big difference. Back when Bill Clinton was elected president, New York Democrats were among the first to put their hands out. Then-New York City Mayor David Dinkins waited a mere 12 hours after Clinton was declared victor to release a 20-page wish-list for the city. But Gotham got little of what it asked for.

One person who understood why this strategy never worked was the late Sen. Daniel Patrick Moynihan. For nearly 25 years Moynihan sponsored a study which charted how much each state sent to Washington in taxes and how much it got back in spending. States like New York, New Jersey, Connecticut, California, and Massachusetts were losers. Toward the end of his life, Moynihan decided that trying to redress this deficit by arguing for more federal spending was fruitless, since the tax increases that financed federal spending ultimately came from the very same states, and politicians in other places weren’t about to let that change. “Keeping more of our money at home,” Moynihan argued, “won’t happen until we break the century-long habit of preferring that it go to Washington first.”

Instead, Moynihan proposed a “new federalism” that created a smaller national government focusing on things like national defense supported by much lower federal taxes rates. Leave money in the states, Moynihan argued, where the citizens of each state could decide what kind of government they want and how much they were willing to spend to pay for it.

Moynihan’s idea, of course, was widely ignored, and since then we’ve gotten bigger national government courtesy of the Republicans, and will get a still bigger one courtesy of Democrats. Which only proves, to paraphrase Runyon again, that the only thing people like Moynihan get for coming up with ideas like that is a reputation for coming up with ideas like that.

So what are powerful House Democrats thinking these days? For one thing, they're not happy with 401(k)s. Granted, no one who has 401(k) money in the stock market has much to be happy about. But it's not just the loss of investor wealth that has Democrats questioning these tax-advantaged retirement plans. They also dislike the plans' freedom of choice and the size of 401(k) tax deductions for higher-paid workers.

The so-called "tax subsidy" of 401(k) plans comes to $80 billion a year, and its biggest beneficiaries are employees in higher tax brackets. A worker making $35,000 and paying income tax in the 15% bracket gets a $525 break by setting aside 10% of pay in a 401(k). A worker making $150,000 and paying in the 28% bracket gets $4,200 from the same 10% deferral.

You can see why this irks the spread-the-wealth party. So it's no surprise that Democrats are intrigued by an alternative plan that would replace 401(k)s with a flat tax credit at all income levels.

Teresa Ghilarducci, an economist teaching at the New School for Social Research in New York, explained the plan at an Oct. 7 hearing before the House Education and Labor Committee, chaired by Rep. George Miller, D-Calif. Miller invited Ghilarducci in his quest to find a replacement for 401(k)s, which he has called "a big failure in terms of providing an adequate retirement for middle-class Americans."

Her proposal has also caught the eye of Rep. Jim McDermott, D-Wash., who chairs the House Ways and Means Committee's subcommittee on income security and child support. A McDermott spokesman calls the plan "intriguing."

Under Ghilarducci's plan, all workers would get a credit of $600 if they invest 5% of their pay into a retirement account run by the Social Security Administration and invested solely in special government bonds paying 3% plus inflation. Existing 401(k)s would be allowed to remain, but contributions and employer matches would no longer be tax-deductible. For want of an incentive, they would wither away.

This plan may have a short-term selling point in its risk-free bonds. Its participants would be in no danger of losing — or making — money in stocks. But a few months from now, the market may look quite a bit brighter and the public may not be so receptive to the idea of trading so much freedom for mediocre, if secure, returns.

Also, the Ghilarducci blueprint has been drawing hostile fire from skeptics on talk radio and elsewhere, so it may not survive the long march into law.

But the real issue here goes beyond any particular tax proposal. It's about motive and means. Leading Democrats share Barack Obama's penchant for redistribution, and they know that there are many routes toward that goal, some not so obvious. They also know how to play on fear — in this case, of stock market risk — as a way to sell ideas that might otherwise be unpalatable to most voters.

We just hope that voters can see past the current panic and recognize that the Democratic Party simply wants more of their money.

If Barack Obama and John McCain agreed on anything, it was this: Greed is bad. They competed in denunciations of reckless investment bankers and avaricious CEOs.

Obama proposed raising taxes on higher incomes (couples above $250,000); though McCain didn't, he suggested that much recent wealth accumulation was ill-gotten. Unintentionally, perhaps, he buttressed the moral case for more redistribution. Let's tap the gold mine of the rich.

Unfortunately, the mine has less gold. All the financial turmoil has left the wealthy — however defined — much less wealthy. Stock ownership is highly concentrated. In 2001, the richest 1% owned 34% of stocks and mutual funds, estimates economist Edward N. Wolff of New York University. Let's see. Since the market's high in October 2007, stocks are down (through Oct. 31) 38%, or $7.5 trillion, reports Wilshire Associates.

That will mean lower capital gains taxes, because capital gains — profits on the sale of stocks and other assets — will plunge. In recent years, capital gains taxes have been running at $100 billion or more. That amount could drop sharply, even if the top rate on capital gains were raised from 15% to its pre-2003 level 20%.

Thousands of well-paid investment bankers, traders, portfolio managers and security analysts are losing their jobs. Though Wall Street bonuses will continue, their total is likely to decrease. Gains in executive compensation may be similarly squeezed. Profits are down; the political climate is hostile.

In 2005, the richest 1% of Americans had 18% of total income and paid 28% of all federal taxes, says the Congressional Budget Office. Their income won't grow much. Even if higher tax rates increase government revenues, the effect will be less than before.

Judged only by economic inequality, the financial crisis is a godsend. It will probably narrow the gap — though still vast — between the rich and everybody else. But what good will that do? Economic inequality also declined in the Great Depression. The country wasn't better off.

By and large, the poor aren't poor because the rich are rich. They're usually poor for their own reasons: family breakdown, low skills, destructive personal habits and plain bad luck.

The presumption implicit in the criticism of growing economic inequality is that society's income is a given and, if the rich have less, others will have more. Up to a point, that's true. The government already redistributes much income, often for the good.

During the boom years, companies might have been less lavish with top executives and slightly more generous to other workers or shareholders. Some new fortunes stem from self-dealing and financial razzle-dazzle, not the creation of real economic value. It's just desserts that some of this wealth has evaporated.

But the redistributionist argument is at best a half-truth. The larger truth is that much of the income of the rich and well-to-do comes from what they do. If they stop doing it, then the income and wealth vanish. No one gets it. It can't be redistributed because it doesn't exist. Everyone's poorer.

This isn't just theory. Last week, Gov. David Paterson of New York pleaded with Congress to provide emergency aid to states. Heavily dependent on Wall Street for taxes, he testified, New York faces a $12.5 billion budget deficit next year and expects joblessness to rise by 160,000.

Wall Street bonuses will drop by 43% and cap gains income by 35%, he estimated. People in New York would be better off if the securities industry were still booming, even if there were more economic inequality.

Americans legitimately resent Wall Street types who profited from dubious investment strategies that aggravated today's crisis. And government properly redistributes income to reduce hardship and poverty.

But that's different from attempting to deduce and engineer some optimal distribution of income. Government can't do that and shouldn't try.

Scapegoating and punishing all of the rich won't do us any good if the resulting taxes dull investment and risk-taking, discouraging economic growth that benefits everyone.

Kennedy-Johnson. By 1960, there was a growing consensus in certain economic quarters for the U.S. to leave the Bretton Woods gold-exchange standard. Happily, John F. Kennedy didn’t heed those words having had the importance of a gold defined dollar explained to him by his father. As Kennedy said, “This nation will maintain the dollar as good as gold at $35 an ounce, the foundation stone of the free world’s trade and payments system.’’

The economy performed well while JFK was alive, and boomed even more once Lyndon Johnson passed Kennedy’s tax cuts posthumously. But as the ’60s wore on, investors increasingly questioned America’s commitment to maintaining the dollar’s relationship with gold. This first showed up in private markets where gold traded far above the Bretton Woods $35/ounce fix, and later in government measures of inflation. By the end of 1968, gold was up 19 percent and consumer price inflation had risen to 4.7 percent. And while LBJ’s presidency imploded for many reasons, one largely unsung factor was that Americans had begun to experience the cruel economic retardant that is inflation.

Nixon-Ford. In the first quarter of 1973, real GNP growth under President Richard Nixon was 8.8 percent, and by October of that same year, the level of unemployment declined to 4.6 percent. Despite these seemingly impressive indicators of economic growth, the electorate was unhappy. As is well known now, Nixon had severed the dollar’s link to gold in 1971, and over the time in question, a major inflationary period began.

With the dollar lacking the credibility provided by its former gold definition, commodities including gold boomed. From 1972 to ’73 oil prices rose 300 percent, meat prices were rising at a 75 percent annual rate, and the price of a bushel of wheat rose 240 percent. But Washington was unaware of the connection with the dollar. After a second dollar devaluation in February of 1973, Treasury Secretary George Shultz said “there is no doubt that we have achieved a major improvement in the competitive position of American workers and American business.” Arthur Burns assured the FOMC that the inflationary impact of the dollar’s devaluation “would be quite small.” Shades of Paulson and Bernanke?

Despite assurances from the monetary authorities, the electorate was not fooled by this hidden tax increase that wiped out its earnings. As the real economy weakened, partly in response to rising inflation, the minor break-in that was Watergate delivered the coup de grace to the Nixon administration.

Though the dollar price of gold actually fell a little under President Ford, the slightly enhanced greenback could not make up for the massive inflation inherited from Nixon, and his “Whip Inflation Now” whereby he urged Americans to spend less quickly became a joke. The inflationary economic baggage of the Johnson and Nixon administrations, combined with an electorate eager for change, ushered in Jimmy Carter’s presidency.

Carter. The Carter story is interesting in that, contrary to modern assumptions, Jimmy Carter presided over one of the longest periods of economic growth in postwar history. Percentage job growth on his watch was higher than any presidency since.

Numbers, however, can be deceiving. In June of 1977, his Treasury secretary Michael Blumenthal and Fed chairman G. William Miller communicated to the markets a desire to see the dollar weaker relative to the Japanese yen. Treasury efforts to talk down the dollar, combined with a mistaken flirtation with monetarism by Fed Chairman Paul Volcker beginning in 1979, led to a 270 percent increase in the dollar price of gold during Carter’s presidency.

Though his feckless approach to foreign policy amidst the Cold War undoubtedly hurt his standing with the electorate, pocketbook issues frequently trump foreign affairs. And with the dollar in freefall, the electorate voted down the stagflationary malaise of the Carter years in favor of Ronald Reagan’s sunny optimism.

Reagan. Indeed, as Reagan’s 1980 election became more apparent to the markets, the dollar’s collapse was arrested. The price of gold spiked above $800/oz. early in the election campaign, and then dropped rapidly. As president, Reagan of course introduced marginal tax cuts, further deregulation of industry, and a stated policy of maintaining a stronger dollar. Though he never achieved his greater desire of returning us to the gold standard, the growth wrought by tax cuts was a dollar positive and the economy soared.

While this subject is debated to this day, some felt the dollar had become too strong midway through Reagan’s presidency. The result was the 1985 Plaza Accord meant to slow the dollar’s rise, combined with the sadly ill-fated Louvre Accord in 1987 meant to stabilize major exchange rates altogether. Still, with the dollar and the economy in good shape overall, Reagan was able to weather the Iran-Contra scandal and ended his two-term presidency with very high approval ratings.

Bush I. George H.W. Bush is the outlier when it comes to inflation, in that the dollar’s value versus gold actually rose during his term of office. Still, he inherited a 33 percent gold-price increase as a result of the Plaza and Louvre Accords. And his presidency was arguably harmed by three unique circumstances that affect the economy in the way that inflation would. Just as inflation is a tax on income, Bush raised the top income tax rate contrary to his public pledge not to during the ’88 Republican convention. And despite the strong relationship between oil prices and the dollar, oil actually rose to $40/bbl. in 1991, perhaps due to fears that the war to liberate Kuwait would compromise the world’s oil supply (through closed shipping lanes) in the near term.

Thirdly, much as inflation reorients investment away from the wage economy, the U.S. experienced a significant credit crunch from 1990-92 not so much due to the S&L debacle, but thanks to Germany becoming a net borrower of capital to finance its reunification. At the same time, a deflationary downturn in Japan similarly led to a reduced supply of capital to the world. The collapse of foreign investment stateside led to a trade surplus in the U.S., and a capital-deficient recession that spoiled Bush’s electoral chances.

Clinton. Bill Clinton stumbled upon his arrival at the White House with tax increases and protectionist positions against Japan that initially weakened the dollar. But perhaps chastened by the 1994 mid-term elections, he among other things replaced Lloyd Bentsen with strong-dollar advocate Robert Rubin at Treasury in 1995.

Rubin’s dollar stance was a transparent factor in the greenback’s rise, and on his watch, Treasury officials ceased the frequent jawboning of the Japanese about the value of the yen. The latter was in and of itself a dollar positive, and was followed by Clinton’s slashing of the capital gains rate in 1997. The administration’s strong-dollar policies combined with reduced penalties on investment were a boon to the economy. Clinton survived the Monica Lewinsky scandal and left office with 60 percent approval ratings.

Bush II. President George W. Bush got taxes right in 2003. But where the dollar is concerned, the second Bush administration has spoken with forked tongue. Though his monetary appointees have paid lip service to the notion that a strong greenback is in our interest, tariffs on steel, shrimp and lumber along with a mercantilist stance against China and its yuan/dollar peg have delivered strong signals to the markets that the administration would prefer a weaker dollar.

Markets have complied, taking the dollar down 40 percent versus major currencies alongside a 240 percent rise in the price of gold since 2001. Bush’s fair imitation of Jimmy Carter when it comes to dollar policy has not only blunted the effects of his tax cuts, but it has also nullified the impressive GDP and job growth that has occurred on his watch. Bush’s approval ratings resemble those of Jimmy Carter.

Interpretation. All this raises the question of why there exists a high correlation between a weak dollar and the fates of presidencies. Much as tax increases reduce take-home pay, inflation erodes the earnings of the electorate. Inflation not only serves as a tax with one hand, it also works against wages with the other through reduced investment.

As the late Robert Bartley wrote in The Seven Fat Years, “inflation always creates winners and losers, redistributing wealth.” Unfortunately for wage earners, when currencies collapse, capital more readily flows into commodities, collectibles and property such that that entrepreneurs and businesses go wanting for capital. Simply put, workers are bitten twice by inflation; first through the reduced value of their earnings, and second with investment slowdowns that make it impossible for employers to increase wages commensurate with rising prices.

Looked at from the perspective of roiling markets today, the “money illusion” created by the weak dollar drove a great deal of capital into housing to the detriment of the metaphysical economy, or what the late Warren Brookes termed the “economy of the mind.” And with wages eviscerated by inflation, it was inevitable that some Americans would eventually struggle with mortgage payments.

And now, with the dollar at historical lows, it’s often remarked that fixing our inflation problem would be painful. This couldn’t be further from the truth. A stronger dollar would bring unmitigated good for increasing the value and amount of wages, thanks to increased investment. It also could have saved the Bush Administration from an inflationary economic legacy that gets worse by the day, and which continues to anger the electorate like no other policy.

Well, for almost two years Obama has talked about cutting taxes for 95 percent of the people. McCain has no such record. And even though McCain has launched a strong Joe the Plumber investor-class tax-cutting surge in the last days of the campaign, it may not be enough to significantly impact Tuesday’s voting results.

This is bad news since Obama has some pretty strange views on taxes. Just look at his recent explanation for the decline in third-quarter GDP. He calls it “a direct result of the Bush administration’s trickle-down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four.”

Is Obama really blaming the Bush tax cuts for this recession?

After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-the-board for individuals and investors. For five years the stock market rallied without interruption -- the longest bull market without a correction in post-WWII history -- while the economy expanded for six years, a bit longer than the average post-war recovery cycle.

And Obama wants folks to believe that tax cuts caused this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and the pressure on Fannie and Freddie to securitize these loans? Not the oil shock?

No self-respecting Keynesian would buy into this. Yet Obama was at it again in Monday’s Wall Street Journal, saying, “It’s not change to come up with a tax plan that doesn’t give a penny of relief to more than 100 million middle-class Americans.”

Regrettably, not even John McCain has contradicted this. But the facts speak otherwise.

For example, the nonpartisan Tax Foundation says the Bush tax cuts -- which McCain would maintain -- provided substantially more relief than middle-class Clinton-era tax rates: A single earner making $30,000 will pay $2,756 under 2008 Bush tax law compared with $3,157.50 under Clinton tax law (in 1999). That’s a larger Bush tax cut by 8.7 percent. A married couple earning $50,000 will pay $4,012 under Bush compared with $5,085 under Clinton. That’s a bigger Bush tax cut by 21 percent.

So the facts of a middle-class tax cut are far different from what Obama claims. Obama also says his tax rates will be below those of Ronald Reagan. Wrong. Obama will raise the top rate to 39.6 percent, whereas Reagan left taxpayers with only two brackets of 15 and 28 percent.

Incidentally, the income cap for Social Security and Medicare taxes was about $42,000 when Reagan left office, compared with $104,000 today and the threat that Obama will raise that cap significantly.

It’s also worth noting that the Reagan tax-reform bill of 1986 mistakenly allowed the capital-gains tax rate to move up to 28 percent from 20 percent. Many believe this was a significant factor in the stock market crash of 1987.

Similarly, Obama intends to raise the cap-gains tax rate from 15 to at least 20 percent. It’s a risky move. Of course, Obama says only rich people will pay the higher cap-gains rate. But the reality is that a cap-gains tax hike will raise the after-tax cost of all capital, which will depress the future value of all equity assets.

McCain has recently proposed a reduction in the capital-gains tax rate from 15 to 7.5 percent. With 100 million-plus investors out there, and nearly two of every three votes in national elections being made by shareholders, this is right on target. Last Friday, McCain told me in an interview that a “low capital-gains tax is probably the greatest incentive for investment that we have in America today.”

In the frenetic final hours of the campaign McCain is also talking up his corporate tax cut, which would be a tremendous boost to plunging stock prices since corporate profits are the mother’s milk of stocks. Indeed, McCain’s overall tax-cut plan is far more powerful than Obama’s when it comes to creating jobs and stimulating economic growth. But his marketing effort appears to be too little, too late.

These things do, however, have a way of balancing out: If Obama and the Democrats go on a tax-hiking spree to penalize successful earners and investors, they will pay for it dearly in 2010 and beyond.

Many large companies, especially those whose growth is behind them, prefer government to protect them from both change (especially in the form of new competition) and the consequences of their mistakes. There are numerous examples of these types of companies in the auto industry, insurance industry, banking industry and even in city and state governments.

The stock market is comprised of companies that are already public, and thus is a measure of successful companies. Ironically, these already successful companies often prefer to be protected from upstarts, the unformed or even the unborn company. There is no stock index of unborn companies. The unborn companies are often incubated in the hatcheries of venture capital firms. They may also start as your average “Joe the plumber” small business or in the dorm room of an entrepreneurial college student.

Microsoft certainly prefers to be protected from an upstart like Google in precisely the same way that Digital Equipment and IBM wanted protection from former upstart Microsoft. In fact, it is clearly in the self interest of well established public companies to encourage and support an environment that strangles current upstarts while they are still in the cradle, thus preventing future competition. If this is doubted, think back to how many large public companies actually supported Sarbanes-Oxley given the knowledge that the law's draconian accounting rules would keep many companies from floating shares altogether.

An environment meant to keep out the upstarts would be characterized by higher capital gains tax rates, more restrictions on trade and capital inflows, higher marginal income tax rates, mandatory health insurance, and greater regulation of products, lending, leverage and the environment. These are all changes that protect the established firms from upstarts eager to take their place at the top of the pyramid.

It is clear that we already have a great deal of socialism here in the United States. And we certainly did socialize some of the housing market with the passage of the 1978 Community Reinvestment Act (CRA), which forced lenders to make non-economic loans that would never have passed muster in a truly free market. The CRA's failure revealed that lenders would have not made many of these loans on their own, yet despite the negative outcome, yesterday's elections show that the electorate wants more of the same.

The political question we must ask now is, “Do we really want more or less socialism?” Do we want the government to continue to tell lenders how they must lend now that “they” have, as Barney Frank said last Friday, “our money?” Do we want the power in the hands of a Congress with a 20% approval rating, a rating somehow lower than even President Bush’s?

If so, there will be consequences to this apparent yearning for more socialism. That is so because tighter regulation, greater government control over the economy, socialization of losses, and more public influence over private decisions will create winners and losers.

The winners in the private sector will be those with influence in Washington, and who support the "enlightened" wisdom of those elected. The losers in this battle for influence are sadly tomorrow's innovators and upstarts, the very unborn companies that presently have no stock market index or influence in Washington.

It is interesting to note that the socialist politicians of Western Europe in modern times, as well as the nationalist, socialist and fascist leaders in the middle part of the century were all put into power by substantial, popular majorities. The powerful winners of today by definition have more political influence than those companies interested in taking their place.

In the end, it is a certainty that a highly regulated economy is far more orderly, while an entrepreneurial, regulation-free economy is far more erratic. But rather than blanch, we should embrace the latter because it is thanks to the "spontaneous order" wrought by free economies that great companies are born.

So while there are those who might deserve punishment for their roles in this financial crisis, the question we must ask is, “Punishment at what cost?” Should the expense be so great that the U.S. and the world miss out on the next Google, Apple, or Microsoft? We think not. In that case, the price of a resurgent state would be way too high.

Apparently Mother Nature wasn't paying attention. The British people, however, are paying attention — to reality. A poll found that 60% of them doubt the claims that global warming is both man-made and urgent.

Elsewhere, the Swiss lowlands last month received the most snow for any October since records began. Zurich got 20 centimeters, breaking the record of 14 centimeters set in 1939. Ocala, Fla., experienced its second-lowest October temperature since 1850.

October temperatures fell to record lows in Oregon as well. On Oct. 10, Boise, Idaho, got the earliest snow in its history — 1.7 inches. That beat the old record by seven-tenths of an inch and one day on the calendar.

In the Southern Hemisphere, where winter was winding down, Durban, South Africa, had its coldest September night in history in the middle of the month. Some regions of the country had unusual late-winter snows. A month earlier, New Zealand officials reported that Mount Ruapehu had its largest snow base ever.

At the top of the world, the International Arctic Research Center reported last month, there was 29% more Arctic sea ice this year than last.

None of this matters, of course, to the warming zealots. It doesn't matter if it's too dry or too wet, too hot or too cold. All of it, they say, is caused by global warming.

We believe, however, as do many reputable scientists, that the warming and cooling of the Earth is a natural phenomenon dictated by forces beyond our control, from ocean currents to solar activity.

The latest warming trend, which appears to have ended in 1998, is the result of the end of the Little Ice Age, which extended from roughly the 16th century to the 19th. During that period, Muir Glacier in Alaska filled Glacier Bay. In fact, when the first Russian explorers arrived in Alaska in the 1740s, there was no Glacier Bay — just a wall of ice where the entrance would be.

As the Earth warmed, long before SUVs roamed the globe, Alaska's glaciers also warmed and began to recede, starting in the 1800s. All that may be changing. During the winter and summer of 2007-2008, unusually large amounts of winter snow were followed by unusually cold temperatures in June, July and August.

"In June, I was surprised to see snow still at sea level in Prince William Sound," says U.S. Geological Survey glaciologist Bruce Molnia. "On the Juneau Icefield, there was still 20 feet of new snow on the surface of the Taku Glacier in late July."

It was the worst summer he'd seen in two decades.

As the Anchorage Daily News reports, "Never before in the history of a research project dating back to 1946 had the Juneau Icefield witnessed the kind if snow buildup that came this year. It was similar on a lot of other glaciers too."

It's been "a long time on most glaciers," Molnia says, "where they've actually had positive mass balance." In other words, more snow is falling in the winter than melts in the summer, making the glaciers thicker in the middle.

Glaciers can appear to be shrinking even as they are growing. Photos taken from ships can record receding edges even as mass is building inland. When they get thick enough, the weight forces the glacier to advance.

The U.S. may owe its ascension to a global power on the global warming that began with the end of the Little Ice Age, which almost doomed the American Revolution. George Washington's famous winter at Valley Forge was part of that natural phenomenon.

As the climate warmed from 1800 to 1900, the U.S. tripled in size, spreading westward to straddle a continent. The population of the windy and very cold trading post known as Chicago grew from 4,000 in 1800 to 1.5 million by 1900, sitting on a great lake carved by glaciers long since receded.

Due to a decline in solar activity and other factors, the Earth is cooling and has been since 1998. And a peer-reviewed study published in April by Nature predicts the world will continue cooling at least through 2015.

Now, if only we could get the warming alarmists to face facts and cool it as well.

All of this is relevant to the present considering the “mood shift” against free trade in Washington. As a Wall Street Journal article from last week noted, Tuesday's “election could put trade-liberalization on ice for a while.”

While the potential shift described above is a major mistake that will surely harm economic growth, it’s also one that shouldn’t surprise us. As McKinnon wrote in his 1996 book, The Rules of the Game, “for each cycle of currency appreciation and depreciation, there will be a tendency for worldwide trade barriers to rise.”

And when we wonder who might be the main miscreant when it comes to monetary depreciation this decade, we need only look inward, or better yet to the U.S. Treasury department. Though Secretaries O’Neill, Snow and Paulson all paid lip service to the importance of a strong dollar, they spoke with a forked tongue.

U.S. dollar policy this decade was decidedly in favor of a weak greenback, and markets complied. Worse, as is frequently the case, foreign central banks followed our lead. This might seem untrue at first glance given the strength of foreign currencies versus the dollar since 2001, but it’s always a mistake to compare currencies that lack any market definition.

So while the dollar was crushed by the euro, Pound and Canadian “looney” (to name a few) in recent years, the strength of all three was illusory; their rise against the dollar simple evidence of how much our currency had fallen. Measured in gold, all three foreign currencies showed impressive weakness, and with inflation batting 1.000 when it comes to economic sluggishness, free trade will be the likely victim of our irresponsibility on the currency front. As the Journal article stated, a “slumping economy, years of stagnating wages for many workers and unease about China” are “fueling popular skepticism toward free trade.”

If we acknowledge that a shift against trade will only make us worse off, it should also be said that the trade skeptics have a point; albeit an incorrect one. Currency debasement always brings about economic slumps because it drives investment away from the metaphysical or entrepreneurial economy, and into the real. This of course explains the pain with regard to wages.

Inflation works against wages first for making essentials such as gasoline more expensive, and then it cuts again for investment moving into hard assets rather than businesses eager to hire and grow. Inflation eviscerates real wages while redistributing wealth, and in periods such as these, workers look for a scapegoat.

It appears China will be our scapegoat, when in truth, China’s rise can only have increased our economic vitality. For one, cheap goods coming from China effectively give all Americans a raise every time they go shopping. For two, when Chinese factories take on low-value work, this frees up limited capital of both the human and investment variety to find higher-value opportunities.

For those who doubt the above, stop and think how poor we would all be if we still had to allocate some of our precious labor to the creation of our clothes, food and appliances. The quality of all three would plummet, plus we would have less time to pursue the work specialties that more likely enrich us, and which enable us to consume that which isn’t in our interest to make.

Many politicians in the trade-skeptic camp claim that as opposed to the imposition of steep tariffs, they’re only looking to make trade “fair” in terms of environmental and safety standards. Don’t be fooled though, because the distinction they’re making is one surely lacking a difference.

Whether it’s tariffs on foreign goods or a requirement that foreign factories resemble ours, the latter will be much the same as the former for making the goods we import far more expensive. To impose workplace rules on developing countries as though they’re developed is the equivalent of England forcing all Americans to drive Rolls-Royces in order for us to sell them our software. Most Americans couldn’t afford a Rolls-Royce, and just the same, foreign factories in developing countries can’t yet afford our workplace standards.

In the end, whatever the rules placed on trade, the rules will constitute an infringement on our liberty as individuals to offer up our surplus in exchange for that of others. Put simply, we get up for work each day to exchange our labor for goods we need. We trade products for products, and when governments set up rules restricting beneficial exchange, they are surely taxing the work we do, which is by definition an economic retardant.

So rather than tax our work, it should be hoped that our minders in Washington recognize the real problem in our midst. Trade cannot be hurtful because when free, it involves two consenting individuals. On the other hand, floating currencies are hurtful for necessarily destabilizing the process by which we produce in order to consume.

Big Labor, which spent more than $53 million in the just-finished election cycle to get Democrats elected, shouldn't have to work hard. The Democratic Congress will be eager to pass the bill, and the Democratic president will be pleased to sign it.

At present, workers vote by secret ballot in union organizing elections to keep coercion to a minimum. But under the card-check system, the potential for intimidation is limitless. Pressure to sign by union organizers could wilt even the strongest man who doesn't want to be a member of the collective.

With a righteous wind at their backs and card-check legislation in their pockets, unions will aggressively try to organize low-price retailers such as Wal-Mart and Target. This might result in higher wages for some workers, but it could also increase prices for consumers as well as drive now-successful retailers into the same economic ditch that unions shoved the U.S. auto industry into.

Then come the layoffs required to offset the higher payroll costs and keep prices competitive. Hurt the most will be those at the bottom of the economic ladder — the very people that Democrats and their union supporters claim to look out for.

Wal-Mart, with 7,000 stores and 2 million employees, is not only the world's largest retailer and one of America's largest employers. With a price structure that has helped keep inflation in check, it's a genuine public benefactor.

Economic analysts at Global Insight found that from 1985 through 2004, domestic retail food prices fell 9.1% due to Wal-Mart's pricing and the competition it provoked. Prices of other goods declined 4.2%, and overall consumer prices eased 3.1%.

Global Insight also reckoned that because of Wal-Mart, consumers saved $263 billion over those years, with a family of five averaging annual savings of almost $225.

A unionized Wal-Mart or Target could also impact health care costs. The $4 prescriptions pioneered two years ago by Wal-Mart, and since matched by Target and drugstore chains, could melt as quickly as an ice cube on a Bentonville sidewalk in August.

A Zogby poll found that 71% of union members agree that the secret-ballot process is fair, while only 13% disagree. Nearly eight in 10 (78%) favor the system the way it is.

Meanwhile, nonunion workers, by more than a 3-1 margin, don't want to join organized labor. Though few in these majorities are likely to understand the economic impact of a card-check law, they have at least found the right side of the issue.

It shouldn't be too much to ask a simple majority in at least one congressional chamber to do the same.

And whatever the Pelosi-Reid juggernaut may do to sell the opportunity society down the river of the nanny state, Obama's victory stands testament to the truth that in America every door is open to anyone who makes good choices in pursuit of a dream. Professional racists from David Duke to Al Sharpton had best find another racket; theirs has run its course.

Perhaps of less importance though meaningful to those who value communications, it will be a relief to have a President who can speak English. We may not always like what he has to say and will often puzzle over his grand vagaries, but at least we won't have to cringe every time he opens his mouth.

But cringe we must as we watch this slow motion train wreck barrel down on the economy. As a person whose job it is to fuel innovation, I can only expect life on the front lines to get harder. The entrepreneurs we back take outsized risks pursuing disproportionate rewards. How is this going to work in a culture that demonizes disproportionate rewards as the government shifts into overdrive to tax them away?

What forces will buffet the limited millions we use to build tomorrow's winners when the printing press floods the market with countless trillions to prop up yesterday's losers?

How much capital will be left for the public to invest in the next Genzyme or Google after it emerges from the VC incubator if all the money is sucked up bailing out dysfunctional banks, bankrupt automotive companies, uneconomic ethanol plants, and reckless consumers?

And by what avenue will our fellow citizens participate in tomorrow's growth opportunities with an IPO market that has been crushed and driven offshore in the name of protecting us from the next Enron?

My constituents, the entrepreneurs who invent and deliver progress, have no lobbyists in Washington. You cannot see the people they hope to employ nor hear their plans for change over the shouts of the entrenched entitled. If we make it a national goal to stamp out income inequality irrespective of its source, what happens when we succeed? No force of nature can make these rare and intrepid individuals quit their day jobs in hopes of striking it rich if you promise them that they can't keep what they win. Just as they abandoned Europe to come here, where will they go next?

My investors can as easily aim their money at new venture creation as seek safety in tax-free municipal bonds. This means that their capital can go to work building transformative jobs that create a surplus to fuel future investment or finance current municipal consumption that will ultimately have to be paid back by future taxpayers. Which will it be in the age of Obama?

Turn away talent at our borders fearing foreigners seeking American jobs, but don't be shocked when those jobs follow them home. Do it long enough and they will eventually stop coming except perhaps as tourists to spend the profits they earned building companies somewhere else.

Pass all the laws you want to punish greedy corporations as you squeeze the wicked five percent, but don't be surprised if the profits you hoped to tax and spread around evaporate or take flight. These people didn't get rich by being stupid. President-elect Obama has eloquently given us ample warning to dodge the bullet of his victory even if we have the magnanimity to celebrate those positive aspects of his success.

The credit crunch hit sales of big-ticket items such as cars almost as hard as housing. For a normal industry, that's cyclical, but for the enfeebled U.S. auto industry, accounting for 4% of GDP, it might be a death knell.

Ford reportedly is bleeding cash so badly it might not make it beyond April. General Motors warns it might not get through to Inauguration Day, and Chrysler has largely the same story. This could have bad effects all through the economy, with 40% of it affected.

Automotive chiefs are meeting with House Speaker Nancy Pelosi with their hands out. At issue: vast pension obligations to 780,000 retired workers that already add $2,300 to the cost of every new car sold. Credit-strapped consumers want value, not pension-inflated price tags. So, the bailout is in the works.

Bankruptcy is a better solution, but if a bailout can't be stopped, taxpayers are owed a reckoning about how this industry got into a situation that a downturn could knock it over. This ought to be a condition for the bailout.

Unions are at the center of every problem affecting industry competitiveness. It's not only the United Auto Workers' lavish pensions, generous health care and leaden bureaucracies, it's unions' reflexive hostility to free trade.Yet if profits matter, new markets can return automotive companies to profitability — and rid the industry of the dead weight of those pensions.

On this front, the automakers are way behind. Compared to Germany, the U.S. is an underexporter, notes Doug Goudy, director of international trade policy at the National Association of Manufacturers. In a good year, about 12 million cars are cranked out. But in 2007, only 1.6 million were exported. Yet exports are the last bright spot of the economy, accounting for nearly all the growth seen in the downturn. Because they are destinations for exports, free-trade countries offer the highest prospects for new growth.

Typically, an efficient plant makes 190,000 cars and is located in the U.S. From there, exports are delivered to niche markets such as Colombia that don't have enough of a market to host a plant.

With 14.5% tariffs, U.S. automakers managed to export just 3,823 vehicles to Colombia in 2007. If the tariff weren't so pricey, they could export many more to a country of 44 million whose per capita GDP recently hit the $7,000 mark, which puts its consumers in a position to buy.

Unions claim trade brings deficits, and that's true in non-free- trade countries such as China. But the U.S. has trade surpluses among the 14 free-trade partners — signalling that exports — and U.S. jobs, not outsourcing, are the basis for the trade.

How can the industry recover so that a financial crackup never happens again? By changing its orientation to increase markets, profits and productivity. Free trade does this, and should be a condition in any bailout.

The result of the first Bretton Woods conference was a system that pegged the US dollar to gold with the other major currencies pegged to the dollar. This system, while having many flaws, was a source of economic stability for 26 years. Other periods of fixed exchange rates (primarily fixed to gold) also produced more stable economic systems than floating rate regimes. This stability can be observed in the low volatility of commodity prices during the fixed periods. During the period of the pure gold standard from 1880-1913 (when the Federal Reserve was established) the standard deviation of commodity prices was roughly 4.5. During the free float period from 1914-1926 the standard deviation at least doubled (there are differences depending on which commodity index is used). During the Bretton Woods era from 1945 to 1971 commodity price volatility was reduced again to a standard deviation of about 8. Since 1971 volatility has again risen to about 15.

If the goal is more stability in the economic system, this new conference must begin to address the exchange rate system. Reducing the volatility of exchange rates and therefore commodity prices is essential to reducing the risk associated with international trade. Billions of dollars have been lost over the last few months alone by companies attempting, unsuccessfully, to hedge exchange rate and commodity price risk. UAL reported a $544 million loss from fuel hedges gone wrong. Citic Pacific Ltd. Lost $1.9 billion from hedging activities related to the Australian dollar. Northwest Airlines took a $410 million write down from losses on fuel hedges. Verasun lost $100 million from hedging the price of corn and ultimately filed bankruptcy. Sadia, Brazil’s second largest food company posted a $410 million loss from currency hedging activities and had their credit rating downgraded. While some of these losses were due to actions outside company hedging policies, they wouldn’t have happened if the need to hedge were eliminated or reduced.

Expectations for the conference are being downplayed and the goals minimized with the strengthening of the IMF seemingly the only concrete expectation. Most of the participant countries seem more interested in regulatory reform and that is certainly necessary and desirable. Even during the stable periods previously mentioned, there were banking crises here in the US. Even in a stable monetary environment, fractional reserve banking has the potential to destabilize. Based on recent experience with leverage, one would think that increasing bank capital requirements is one item that could be agreed upon. Other ideas, such as closer supervision of hedge funds and credit rating agencies, may not be necessary if monetary reform and banking reform are properly addressed.

The global imbalances much discussed over the last few years are exactly what the IMF was designed to address. When the IMF was founded along with the World Bank, the first Bretton Woods conference placed them in the context of a stable monetary system. Reforming the IMF without reforming the monetary system will not yield a more stable system. We would have to depend on the IMF not only to anticipate problems but also to act on them in a politically charged environment. The performance of the IMF since the fall of the first Bretton Woods agreement suggests that is too much to ask.

Monetary reform will not be easy. China and most of the emerging Asian economies will fight hard to maintain a currency advantage that they see as vital to the growth of exports that have fueled their past growth. The US will be reluctant to agree to a system that weakens the role of the dollar as the world’s reserve currency. The Europeans will press for a greater role for the Euro in international trade. These three currency blocs will all have their own agendas but the current global economic slowdown may be the perfect opportunity to address the issue of monetary reform. Global economic cooperation is no longer optional; this crisis has affected every region of the world.

Over the last 60 years we have witnessed a movement toward freer trade, freer markets and freer movement of capital that has raised living standards around the world. That movement accelerated over the last 30 years and the reduction in world wide poverty during that period is nothing short of astounding. It is critical that we construct a global monetary system that provides a stable structure within which we can extend this record and realize the full benefits of the free market.

Financial accounting is intended to provide an accurate value of an asset at a point in time. Mark-to-market accounting, at its base level, is what financial accounting is intended to provide. When we look at a company’s balance sheet we are attempting to get a “snap-shot” of the value of the company’s assets and liabilities as of a specified date. The balance sheet is intended to answer such questions as: What is the value of the company’s cash account? What is the value of the company’s accounts receivables? What is the value of a company’s investments?

The balance sheet attempts to answer these questions as of a certain date, not in some unattainably objective manner.

For cash, it is an easy question. The value of a cash account is the amount of cash in the account. For accounts receivable, it becomes more complex. We know what the company is owed, but we also know that 100% of the debts owed to the company are unlikely to be paid, so we create a loss reserve based on past history and future assumptions.

For securities, in a mark-to-market system, we estimate the current value of those securities based upon the amount for which the asset could be sold as of the relevant date. If there is a liquid market for these assets, then it is almost as easy to determine the value of securities on a given date as it is to determine the value of cash. These securities simply have a value equal to that amount for which similar securities have recently been sold in the market.

The current drumbeat to jettison mark-to-market accounting relies upon the negative impact such accounting treatment is currently having on a company’s balance sheet. The prime example of these types of securities at the moment are subprime CDOs.

Permanently allowing for the termination of the use of mark-to-market accounting on these securities would allow firms to treat securities more like accounts receivable and less like cash. The estimated value would be based upon some historical and assumed future actions of third parties. But these securities are not securities intended to be held until maturity, like accounts receivables. They are investments purchased in hopes of selling for a gain.

Nevertheless, in the current market, it may be fitting that a temporary revision to mark-to-market accounting be undertaken; however, allowing accounting to be permanently altered based upon this short term crisis would be equivalent to throwing the baby out with the bathwater. In a free market economy assets are worth what another will pay for those assets and must be reflected as such in a company’s financial statements. Otherwise, the financial statements are a contrivance that will be shown to be such at an inopportune time in the future.

The fundamental goal of any of the new regulations sure to follow the current market crises should include mark-to-market accounting as a guiding principle. Any new bank capital requirements will need to insure that banks do not lend beyond their means, bankruptcy laws should insure that a bankrupt firm (regardless of size) can be wound-up or revived in an orderly fashion, and securities laws should insure that markets have visibility into relevant risks. If regulatory reforms are properly implemented, mark-to-market accounting works. If mark-to-market cannot work under any newly proposed regulations, such new regulations should not be enacted.

Financial accounting in a free market economy is based upon the principle that an asset’s value is equal to the amount another is willing to pay for such asset. No more, no less.

The above is the case because businesses rarely fail due to a lack of money. Instead, poorly run businesses find it hard to raise money in the capital markets. Government money allows the architects of bad decisions to continue making mistakes that cause a company to be capital deficient to begin with.

This distinction is important considering the efforts of GM’s present management to secure more funds on top of the low interest loans that Congress recently approved. Were GM well managed it would have no need to run to the federal government, but because its management has proven time and again that it lacks ability, capital is correctly searching for better opportunities.

Some, including the Washington Post’s Steven Pearlstein, argue that release of rescue funds should be contingent on a change of management. That sounds good at first, but then if GM had better management, it would decidedly not need the federal funds it presently seeks.

Last Friday President-elect Barack Obama described U.S. carmakers as “the backbone of American manufacturing”, and while his claim is charitably dubious, assuming he’s right, he merely strengthens the argument suggesting GM should be allowed to go bankrupt. That is so because paradoxical as it sounds, GM’s bankruptcy would be a boost for Michigan’s economy and the U.S. auto sector generally.

Far from vanishing, many of GM’s assets would be quickly purchased by competent foreign automakers eager to expand their capacity in what is the world’s largest auto market. Happily, the list of well-run car companies, from Toyota to Nissan to Porsche, is long.

How this helps Michigan, the auto sector and smaller firms reliant on the latter’s health is pretty clear. With capable auto executives finally overseeing GM’s poorly deployed assets, the value and utility of each would rise, thus perpetuating the existence of jobs in the sector, all the while insuring that other businesses that exist due to GM will enjoy more stable commercial relationships with competent management. So while the cries of certain Armageddon would be earsplitting in the event of a GM failure, the U.S. auto sector would actually emerge much healthier thanks to a change in ownership that would be the certain result of GM going under.

Obama also noted that “we are facing the greatest economic challenge of our lifetime, and we’re going to have to act swiftly to resolve it.” While some would find Obama’s strident tone overdone, if he’s in fact correct, his stance speaks to the importance of the government standing aside with regard to GM’s troubles rather than giving the firm more capital to destroy.

That is the case because economies only struggle when capital is lacking. Otherwise they grow for capital funding new and existing ideas that create wealth and new jobs.

So in a sense there’s a moral aspect to letting GM implode. Indeed, with companies not in the auto sector presently shedding workers due to a lack of funds, how could Obama or the outgoing administration take even more precious capital from the private sector in order to keep alive a firm notorious for its prodigious misuse of the money offered it?

The better answer for a capital-starved economy would be for the federal government to once again get out of the way, and in doing so, let funds flow to the very best ideas to insure as quick a recovery as possible. Importantly, if investment proves non-existent for GM absent government largess, it’s a certainty that foreign carmakers will step in amid the firm’s bankruptcy in such a way that job losses will be much less of a problem than is often assumed.

If there’s a defense of GM at this point, it has to do with dollar policy in this country that has made long-term planning very difficult. GM did relatively well when the dollar was strong due to lower gasoline prices that made its large vehicles very popular. But as GM presently seeks to create new, smaller models for a world allegedly running out of oil, a stronger dollar has driven down gasoline prices, which means its inventory might yet again not match future economic realities. The complication there is that GM’s management has regularly advocated a weaker dollar, so the problem remains one of management clueless when it comes to understanding what makes the firm prosper.

In the end, the state of Michigan and the U.S. automobile sector are struggling not due to back luck, but precisely because they cling to a company that investors no longer value. And with GM shares near all-time lows, those with capital are stating loudly that so long as GM remains as is, the funds necessary for job creation will continue to flee.

So rather than waste precious capital in the naïve hope of propping up that which investors don’t value, it’s essential to let GM fail. Only then will a necessary change of ownership occur; the latter change the only solution when it comes to properly utilizing assets whose misuse is presently destroying a formerly great company, not to mention the economic health of the state in which it is headquartered.

As a former U.S. Commissioner for Civil Rights under three Presidents, I celebrate the achievement of my country in electing an African American to our nation’s highest office. It is amazing to me that in my lifetime we¹ve gone from Jim Crow segregation to the election of Barack Obama as President. As an economist, I am one of many who worry about the economic costs of President Obama¹s policies. But also as an economist, I see that there is a substantial benefit to reducing the economic friction of race awareness, ending the “victim” mindset and increasing human potential. .

Discrimination is not over, but Obama’s election diminishes the manipulative power of the race card. It takes away the excuses for why, “I can't.” It forces the youth of our nation to embrace opportunity instead of falling back on victimhood. Already in communities across my state of California, there is a palpable improvement in the mood between the races. Local leaders are beginning to hold youths who hang out on street corners to a higher standard. Something is already different.

T. Boone Pickens is not the first person to point out the destructive effects of sending hundreds of billions of dollars abroad, much of it to countries that don’t like us very much, to pay for fuel that we can and should produce for ourselves.

As former CIA Director Jim Woolsey never tires of pointing out, we are effectively financing both sides of the war on terror. That needs to stop.

Nor should the American economy remain forever a hostage to OPEC, vulnerable to opportunistic manipulation of the markets by a foreign government cartel. That too needs to stop.

We have it within our power to transition to a cleaner, affordable, more secure, domestically produced energy supply -- not overnight, but over the next 20-30 years. We have set in motion a series of policies that will lead us in that direction. These policies are already paying dividends. They should be continued, and strengthened.

Specifically, President Bush has proposed to reduce U.S. gasoline consumption by 20 percent over ten years. Pursuant to that goal, the Congress has passed and the President has signed a Renewable Fuels Standard calling for the production of 36 billion gallons of biofuels by 2022. Coupled with significant increases in engine efficiency and widespread adoption of hybrid and plug-in hybrid automobiles in the years ahead, this has the potential to dramatically shift the balance of power in energy markets in favor of American producers and consumers.

This is a big undertaking, and it should be acknowledged that ethanol is not the sole solution to our energy woes. We need to expand domestic production of oil and natural gas. The United States and Canada have a very large tar sands and oil shale resource. Clean, safe, next generation nuclear plants and clean coal hold enormous potential for electric generation. Wind, solar, biodiesel, and other renewable energy resources will become increasingly important in the years ahead. At some point in the future, all-electric or hydrogen fuel cell vehicles may revolutionize the automobile.

But that day is yet to come. At this time -- and for the foreseeable future -- ethanol has a critically important role to play. In 2000, the United States produced 1.6 billion gallons of ethanol. This year, production will exceed 9 billion gallons. Our current ethanol production is corn based, but second and third generation biofuels utilizing non-food feed stocks hold even greater potential. In fact, as these new technologies become cost-competitive, USDA and the Department of Energy (DOE) have estimated that we can supply as much as 30 percent of the nation’s transportation fuel needs with ethanol. That percentage is likely to grow as current feed stocks are genetically enhanced and as entirely new feed stocks are developed.

Earlier this year, DOE’s economists estimated that ethanol is saving U.S. motorists 20-35 cents per gallon of gasoline. Our taxpayer’s investments to help develop the ethanol industry are already paying off as our citizens saved an estimated $20 - $40 billion this year alone from adding this renewable fuel to the blend of gasoline. Ethanol is already making a tangible difference to American households while reducing imports and slashing greenhouse gas emissions by an estimated 19 percent, as compared to gasoline. Ethanol is good for consumers, good for farmers, good for the environment, and good for national security, and USDA is proud to be a partner in helping to bring this strategic industry to maturity.

Now, before I go any further, I should point out that I have not made up this press release. Nor is this something I lifted from the website of the Onion, the satirical newspaper which specializes in printing outlandish fake news stories.

That I had believed this was satire when I first read it just shows that I am only slowly adjusting to the new spirit of the times in which “bailout” and “stimulus” are the hottest buzzwords in policy circles. If I had been paying closer attention, for instance, I would have noticed that around the same time that the ALA issued its plea, various state governors implored the federal government to come up with $14 billion in new infrastructure stimulus spending for them.

Meanwhile, providers of green energy equipment were applauding inclusion of tax credits for renewable energy sources in the Emergency Economic Stabilization Act of 2008 because of the potential stimulative effect of so many businesses and residents running out to install wind, geothermal and biomass energy products. Not to be left behind, developers and owners of commercial real estate warned that the government needs to expand its next economic stimulus package, set to be debated in early 2009, to include them, or else risk having a slump in the commercial market drag the overall economy down further. I’m sure one reason they see nothing unusual about this request is because the auto industry is asking for a $25 billion bailout from troubles that started decades ago—not during the current crisis. After all, General Motors and Ford collectively lost some $10 billion on their North American operations in 2005, when the rest of the U.S. economy was humming along.

What we are watching is the rapid evolution of the meaning of words like “bailout” and “stimulus,” and we’ll certainly be poorer for it in the long run. When the federal government first seized control of Fannie Mae and Freddie Mac, then engineered the merger of Bear Stearns and JPMorgan Chase and saved AIG, we were so shocked that many of us accepted the explanation that these actions amounted to rescues necessary to save our financial system from serious, long term damage. But the word “bailout” has now been used so many times that it is slowly coming to mean simply offering aid. And everyone seems ready to line up for it.

This is where the word “stimulus” comes in. The term “bailout” has provoked such a backlash that the only way panhandlers rattling their cups in Washington can justify their requests is to pretend that they cost nothing. That’s why all of these bailouts are somehow stimulative, too. And thus, for every dollar we invest in libraries, we’ll get back more than five dollars. That’s a return-on-capital that you can’t find on most investments, although the ALA doesn’t explain how it arrived at its wonderful numbers, and I’d love to see the research that produced them subjected to peer review.

Perhaps by trying to convince us that all of this spending will pay for itself—and give back even more—the panhandlers hope we won’t ask tough questions about who is really responsible for the mess each is in. Some states and local governments, for instance, have used up much of their bonding authority on extravagant, unwise and sometimes downright silly projects like massive subsidized convention centers, sports arenas and stadiums. States also spent money liberally during the go-go years and find their budgets pinched today. So, they complain that Washington isn’t providing enough money to help with essential building and repairing of local roads, bridges and tunnels and demand $14 billion of stimulus aid. If this kind of building is so stimulative, however, you have to wonder why the states and cities haven’t rushed to take money from elsewhere—say from earmarks or from rich public employee contracts—and diverted it into infrastructure projects instead of waiting for Washington to act.

Bailout money may not truly stimulate, but it does insulate. If states can rely on billions from Washington, they won’t reform their budget processes, refocus their own borrowing, or tap innovative sources of capital, like private equity pools around the world that are investing in infrastructure. If struggling private industries can rely on aid from Washington to prop up assets and failing operations, prices won’t fall enough to attract new investors and innovative and efficient new firms. Both scenarios are a prescription for a society of sclerotic public and private institutions.

Still, expect plenty of groups to line up with their tin cups when Congress reconvenes and begins discussing the next stimulus package, which may very well lower the mortgage principal of millions of subprime borrowers and spread assorted other aid around, especially to constituencies which get a stronger hearing with a new presidential administration. $100 million here. $14 billion there. $25 billion there. These days, it's what panhandlers call "spange," that is, spare change.

Maybe they should regard the situation as a message from above. State and local governments are already drowning in debt, much of it in liabilities for public employee pensions that were underfunded to begin with, and are now even more so after losing tens of billions in market value during the recent economic slump.

To issue more debt when they know they don't have the money to pay future pension liabilities is foolish.

Analysts at the National Bureau of Economic Research have found that state pensions alone are expected to grow to about $7.9 trillion in 2005 dollars over the next 15 years. There's a 50% chance, they say, that the pensions will be underfunded by $750 billion by that time, and a 25% chance they will be underfunded by "at least $1.75 trillion," which will be about one-tenth the size of the economy.

To put this in perspective, consider that the NBER report says that underfunding in state pension plans is larger than the total magnitude of outstanding state bonds. Add in the underfunded pensions for which counties and cities are liable, and which runs the percentage of underfunded state and local pensions to 40% of all public pensions, and the mix is a toxic brew of debt.

So who is going to be responsible for the debt run up by reckless elected officials eager to provide luxury — and often outrageously early — retirements for civil servants?

Primarily the next generation's taxpayers, who will reap few if any benefits from services they'll be forced to pay for, as well as those who are not yet paying serious taxes but one day will be.

Unless they have no qualms about bankrupting future taxpayers, the elected officials who have overpromised, and those who have made no serious attempts to fix their predecessors' errors, need to muster the will to require their employees to contribute more to their own pensions.

Better, though, would be to move away from the traditional defined benefits system, in which a pension is a percentage of a worker's final salary paid from investments made by the employer, to a defined contributions system, in which workers pay into, and assume the risk of, individualized accounts.

Unless there are significant changes, American taxpayers will be burdened as never before and the economic strain on the nation could well be unprecedented when the bill for these pensions comes due. Retired public employees will be better off than most, but they will be living in a world where the standards are far below those we enjoy today. That doesn't sound like a retirement to look forward to.

Leaders of the G20 nations are meeting this weekend to discuss financial markets and the world economy. Announced just a few weeks ago, this summit is both very unprepared and very important. The world economy and world financial markets are in a delicate state.

Governments and central banks staunched the bleeding in their financial systems, but they seem unprepared for the next round of difficulties. Difficulties that will arise as the recession deepens and widens, and financial crises spread to emerging markets. Economically and financially, there is a sense that things are spiralling out of control again.

The G20 meeting in Washington next weekend is an opportunity for the leaders to show that they have the will to get out ahead of the global crisis; to assure firms, workers, savers, consumers and investors that governments are able to fix the world economy.

In anticipation of this meeting, we asked world-class economists from around the globe to write 1000 word essays on what the G20 leaders should do.

The authors – Alberto Alesina, Erik Berglöf, Willem Buiter, Guillermo Calvo, Stijn Claessens, Paul De Grauwe, Wendy Dobson, Barry Eichengreen, Daniel Gros, Refet Gürkaynak, Takatoshi Ito, Vijay Joshi, Yung Chul Park, Raghuram Rajan, Dani Rodrik, Michael Spence, Guido Tabellini, David Vines, Ernesto Zedillo and Jeromin Zettelmeyer – identify four priorities for action:

In the financial sector, leaders should act quickly, strengthening and coordinating the emergency measures to staunch the bleeding; in the real sector, they should use fiscal stimulus to get the patient’s heart pumping again;

They should act immediately to strengthen the ability of the IMF and other existing institutions to deal with the crisis in emerging markets;

They should start thinking outside the box about longer term financial and monetary reforms; and

Do no harm.

The book is full of ideas of things that could be agreed. Nobel Laureate Michael Spence suggests that a variety of coordinated interventions from central banks, the IMF, large holders of reserves and others could help reduce the extent of an asset-deflation overshoot and reduce the burden that is placed on fiscal stimulus to restore economic growth. Former Mexican President Ernesto Zedillo (Yale Phd), the man who guided Mexico through the 1997/8 crisis, fears nothing on the financial side can be agreed at this meeting, but the Summit could be saved if the leaders agreed to re-energise the WTO Doha Round talks.

The E-Book can be freely downloaded here

Here are the titles, authors and short summary of all 17 essays.

Quick action for the real economy; sober reflection for financial regulation
Alberto Alesina and Guido Tabellini

Regulatory reforms are surely needed, but this is not what G20 leaders can or should decide at this meeting; hasty new regulations could easily make things worse. The urgent need is for coordinated action to stimulate the global economy with fiscal and monetary measures. Allowing for varying national situations is essential.

Coordinated responses versus identical responses
Refet S. Gürkaynak

The G20 leaders face two related but distinct problems: mitigating the economic damage of the global recession, and reducing the chances of future financial crises. The recession requires coordinated macroeconomic stimulus, but coordinated need not mean identical. The leaders should also discuss financial regulation, but a unified financial regulatory framework for the whole world is unreachable and undesirable. Leaders should waste no time on this; national financial systems vary too widely and some are already over-regulated.

Agenda for the next few months
Michael Spence

Leaders should focus first on limiting the damage from this crisis in developed and developing nations. Coordinated interventions to prevent asset-price overshoot and provide fiscal stimulus are important. The longer term regulatory issues should await a careful analysis of the causes of the crisis.

Making international finance safe for the world economy – not the other way around: What should the G20 communiqué say?
Dani Rodrik

G20 leaders should unite against unilateral actions that could tip the world into a vicious cycle that deepens the global recession. This should include: (i) coordinated fiscal expansions that include consumption-expanding measures by nations with large trade surpluses; (ii) commitment to abstain from protectionist measures; and (iii) commitment to expand funding of the IMF’s Short-Term Lending Facility as needed. Finally, leaders should establish a high-level working group to design new ‘traffic rules’ for international finance.

Some suggestions for the G20 on November 15th
Willem H. Buiter

G20 leaders should better coordinate their crisis ‘firefighting’ efforts including recapitalisations, lending guarantees, fiscal expansions, and toxic-asset valuations. They should also set in motion institutional reforms: (i) establishing a new G7/8 (US, EU, Japan, China, India, Brazil, Saudi Arabia and possibly Russia or South Africa) with the IMF as its secretariat; (ii) boosting IMF lending capacity, and; (iii) creating a uniform global regulatory framework for rating agencies and for large, highly-leveraged institutions with significant cross-border activities.

Reforming global economic and financial governance
Raghuram Rajan

G20 leaders should focus on global governance and should boost the IMF’s financial firepower. Global financial coordination requires a broader group than the G7 or G20. The EU should get only one chair in the “G20+” to allow broader representation. The Secretariat for this group should be a reformed IMF. The IMF’s lending capacity should be immediately increased by allowing the Fund to leverage its member quotas at a ratio of between 5 and 10 to 1.

Not a New Bretton Woods but a New Bretton Woods process
Barry Eichengreen

The November 15th meeting should explore the idea of a new “World Financial Organization” that, like the WTO, would blend national sovereignty with globally agreed rules on obligations for supervision and regulation. It should agree to immediately boost the IMF’s lending capacity, with nations like China contributing in exchange for a revamping of the old G7/8 group into a new G7 (US, EU, Japan, China, Saudi Arabia, South Africa and Brazil) that would provide a proper global steering committee.

The new international financial architecture requires better governance
Stijn Claessens

New rules and institutions are needed to reduce systemic risks, improve financial intermediation, and properly adjust the perimeter of regulation and supervision. This could mean an “International Bank Charter” for the world’s largest, most international banks with accompanying regulation and supervision, liquidity support, and remedial actions as well as post-insolvency recapitalisation funds in case things go wrong. The starting point, however, has to be a change in the governance of the international financial system.

Europe’s two priorities for the G20
Daniel Gros

G20 members should boost IMF independence so it can act as a global ‘whistleblower’ to help call the next crisis. They should also start to bring the reach of banking supervisors more in line with the reach of banks. The failure of regulators to exchange confidential information led national agencies to miss the systemic risk that arose when banks across the global followed similar strategies.

Returning to narrow banking
Paul De Grauwe

Bubbles and crashes have been part of financial markets for centuries. Allowing banks – which inevitably borrow short and lend long – to get deeply involved in financial markets is a recipe for disaster. The solution is to restrict banks to traditional, narrow banking with traditional oversight and guarantees while requiring firms operating in financial markets to more closely match the average maturities of their assets and liabilities.

G20 Summit: What they should achieve
Takatoshi Ito

Four issues demand G20 attention: (i) improved surveillance mechanisms to avoid future crises, (ii) reinforced liquidity support for small nations hit by shocks originating from other nations, (iii) better coordination of national financial supervisory and regulatory frameworks, and (iv) international agreement on bankruptcy procedures for large banks with extensive transnational involvement. Reform of the IMF is critical to all of these.

Delivering change. Together.
Wendy Dobson

Leaders should observe several key principles: (i) do no harm; (ii) avoid finger pointing; (iii) moderate expectations of global action; (iv) be unanimous in selecting a few goals and then deliver. The priorities should be to agree a coherent regulatory framework (new rules, not a new institution), hasten IMF restructuring, stimulate the real economy and permanently replace the old G7 with the G20.

East Asia’s Self-managed Reserve Pooling Arrangement and the global financial architecture
Yung Chul Park

The G20 leaders should recognise the stabilising role that Europe’s regional financing arrangements play in the global structure and encourage the completion of a corresponding arrangement in East Asia. G20 nations should collaborate to make the SRPA a credible regional lender. This requires enlarging the SRPA’s reserve pool, ensuring that attached policy conditions are no more stringent than the IMF’s SLF, and making the disbursement process straightforward and expeditious.

The New Bretton Woods agreement
Guillermo Calvo

The crisis is spreading to the ‘South’. To offset ‘sudden stop’ disruptions, multilateral lending capacity should rise fivefold. Credit lines, like those extended by the Fed to struggling nations, need to be paired with regulations to discourage capital flight, and capital controls more generally should be viewed as useful tools for particular circumstances. Finally, in the longer run, serious attention should be paid to the creation of new or extended common currency areas.

A New Bretton Woods system should curb boom and bust
Vijay Joshi
David Vines

Today’s crisis has roots in a risky international monetary system as well as a risky financial system. Current international monetary arrangements encourage boom and bust cycles. G20 leaders should aim to build a system that induces nations to manage their macroeconomies in ways that produce neither financial bubbles nor large external imbalances and inappropriate exchange rates.

Targeted improvements in crisis resolution, not a New Bretton Woods
Erik Berglöf
Jeromin Zettelmeyer

The current crisis reveals two major flaws in the world’s crisis-resolution mechanisms: (i) funds available to launch credible rescue operations are insufficient, and (ii) national crisis responses have negative spillovers. One solution is to emulate the EU’s enhanced cooperation solution at the global level, with the IMF ensuring that the rules are respected.

Save Doha to save the G20 Summit
Ernesto Zedillo

A meaningful agreement that starts to reduce the world’s global economic governance deficit is simply not possible at the G20 meeting. But the G20 Summit need not be a disappointment. Plan B should be to save the Summit by saving the Doha Round.

Emerging markets’ external and fiscal positions have been stronger than ever, thanks to the hard lessons learned from their own crisis-prone history.

We might even have allowed these countries a certain measure of schadenfreude in the troubles of the United States and other rich countries, just as we might expect kids to take perverse delight from their parents’ getting into the kinds of trouble they so adamantly warn their children against.

Instead, emerging markets are suffering financial convulsions of possibly historic proportions. The fear is no longer that they will be unable to insulate themselves. It is that their economies could be dragged into much deeper crises than those that will be experienced at the epicenter of the sub-prime debacle.

Some of these countries should have known better and might have protected themselves sooner. There is little excuse for Iceland, which essentially turned itself into a highly leveraged hedge fund. Several other countries in Central and Eastern Europe, such as Hungary, Ukraine, and the Baltic states, were also living dangerously, with large current-account deficits and firms and households running up huge debts in foreign currency.

Argentina, the international financial system’s enfant terrible, could always be relied on to produce a gimmick to spook investors — in this case a nationalization of its private pension funds.

But financial markets have made little distinction between these countries and others like Mexico, Brazil, South Korea, or Indonesia, which until just a few weeks ago appeared to be models of financial health.

Consider what has happened to South Korea and Brazil. Both economies have experienced currency crises within recent memory — South Korea in 1997-1998 and Brazil in 1999 — and both subsequently took steps to increase their financial resilience. They reduced inflation, floated their currencies, ran external surpluses or small deficits, and, most importantly, accumulated mountains of foreign reserves (which now comfortably exceed their short-term external debts). Brazil’s financial good behavior was rewarded as recently as April of this year when Standard & Poor’s raised its credit rating to investment-grade. (South Korea has been investment-grade for years.)

But both are nonetheless getting hammered in financial markets. In the last two months, their currencies have lost around a quarter of their value against the US dollar. Their stock markets have declined by even more (40 percent in Brazil and one-third in South Korea). None of this can be explained by economic fundamentals. Both countries have experienced strong growth recently. Brazil is a commodity exporter, while South Korea is not. South Korea is hugely dependent on exports to advanced countries, Brazil much less so.

They and other emerging-market countries are victims of a rational flight to safety, exacerbated by an irrational panic. The public guarantees that rich countries’ governments have extended to their financial sectors have exposed more clearly the critical line of demarcation between “safe” and “risky” assets, with emerging markets clearly in the latter category.

Economic fundamentals have fallen by the wayside.

To make matters even worse, emerging markets are deprived of the one tool that the advanced countries have employed in order to stem their own financial panics: domestic fiscal resources or domestic liquidity. Emerging markets need foreign currency and, therefore, external support.

What needs to be done is clear. The International Monetary Fund and the G7 countries’ central banks must act as global lenders of last resort and provide ample liquidity — quickly and with few strings attached — to support emerging markets’ currencies. The scale of the lending that is required will likely run into hundreds of billions of US dollars, and exceed anything that the IMF has done to date. But there is no shortage of resources. If necessary, the IMF can issue special drawing rights (SDRs) to generate the global liquidity needed.

Moreover, China, which holds nearly $2 trillion in foreign reserves, must be part of this rescue mission. The Chinese economy’s dynamism is highly dependent on exports, which would suffer greatly from a collapse of emerging markets. In fact, China, with its need for high growth to pay for social peace, may be the country most at risk from a severe global downturn.

Naked self-interest should persuade the advanced countries as well.

Collapsing emerging-market currencies, and the resulting trade pressures, will make it all the more difficult for them to prevent their unemployment levels from rising significantly. In the absence of a backstop for emerging-country finances, the doomsday scenario of a protectionist vicious cycle reminiscent of the 1930s could no longer be ruled out.

The United States Federal Reserve and the International Monetary Fund have both taken some positive steps. The Fed has created a swap facility for four countries (South Korea, Brazil, Mexico and Singapore) of $30 billion each. The IMF has announced a new quick-dispersing short-term facility for a limited number of countries with good policies. The questions are whether these will be enough and what happens to those countries that will not be able to avail themselves of these programs.

So when the G-20 countries meet in Washington on Nov. 15 for their crisis summit, this is the agenda item that should dominate their discussion. There will be plenty of time to debate a new Bretton Woods and the construction of a global regulatory apparatus. The priority for now is to save the emerging markets from the consequences of Wall Street’s financial follies.

Dani Rodrik is Professor of Political Economy at Harvard University’s John F. Kennedy School of Government. His latest book is “One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.”

Roubini’s analysis has attracted a lot of attention of late for his view that the moderation of this decade’s housing boom would lead to a financial crisis. The problem with his thinking involved his assumption that housing is an essential input to real economic growth.

The above sounds nice on its face, but whether it’s New York, Los Angeles or Palo Alto, housing in all three was and will continue to be a consumptive effect of otherwise strong economic growth. Housing surely didn’t build any of the three cities (nor did it grow Miami, Dallas or Seattle either), but thanks to productive economic activity in all three, housing was the certain consumptive result.

Importantly, just as housing was the hot asset class in the early and late ‘70s, so was it this decade not due to economic growth per se, but thanks to currency debasement that always leads to a flight to the real. In short, the subsequent moderation of home prices has not been an economic retardant so much as it’s been the result of economic sluggishness that always reveals itself when currencies are allowed to weaken.

Roubini holds the reputation of soothsayer at present, but the very analysis that has made him all-seeing was faulty on its face. Lower home prices are an undeniable good for less capital going into the ground, as opposed to the entrepreneurial economy. What led to housing’s moderation of late was paradoxically what caused its boom. When currencies decline, hard assets do well, and investment in real economic activity withers.

But the money illusion that bolsters the nominal price of hard assets such as housing only lasts so long. Eventually the economy had to atone for monetary mischief, and with currency debasement bating 1.000 when it comes to economic hardship due to the aforementioned investment slowdown working in concert with the evisceration of paychecks, the servicing of mortgage debt was eventually going to be difficult.

In short, Roubini made the correct call a few years ago about looming economic difficulty, but the call ignored the real cause which decidedly was the weak dollar. Happily for Washington’s political class, Roubini’s suggestions for “stimulating” the economy absolve it of its own mistakes, all the while allowing it to do what it does best: spend the money of others.

Indeed, rather than proposing that Congress follow its constitutional mandate when it comes to shoring up and stabilizing the dollar’s value, Roubini’s economic prescription was surely music to many legislators’ ears. He asked for a second stimulus plan of $300 to $400 billion, which would dwarf the previous one by a multiple of three.

But if mere government spending were the solution to our economic troubles, one might ask why Roubini is being so thrifty. Instead of $400 billion, why not $1.2 trillion?

Importantly, the answers why are obvious. If the federal government spends $400 billion to stimulate the economy, then the private citizens from whence that money came would have $400 billion less to spend or invest in the private economy.

Roubini testified that absent the stimulus he proposes, “Six months from now, everything we’ve done to backstop the banks is going to be undone by a collapse in aggregate demand.” What Roubini misses is the origin of what he deems aggregate demand.

Put simply, there is no aggregate demand to speak of absent productive work effort first. The ability of any individual to demand things is the direct result of that same individual’s productivity; that or the productivity of others who are then willing to lend in order for the same individual to consume. So when the federal government taxes the private economy in order to pass around money, there is no economic growth to speak of. Worse, taxes are nothing more than a price put on work effort, and if they’re raised to fund stimulus plans, the incentives of the productive to work more are reduced.

And there lies the major fallacy of Roubini’s latest economic analysis. Captive to an economic model centered on demand, Roubini believes the path to economic recovery lies in reaching into one set of pockets in order to line the pockets of others.

The above certainly cannot be true based on simple logic. Generator of no revenues itself, the federal government can only spend to the extent that private individuals produce. Looked at from today’s perspective, the federal government is only able to spread the wealth created by others if the “others” are working productively in the private economy such that the government has true wealth to tax. You can’t profit from the same transaction twice, but in the fantasy world of Washington and certain economists, this is a possibility.

Basic economics tells us something quite at odds with today’s conventional wisdom. Given the reality that any government’s ability to spend is the direct result of real economic growth, fallacious assumptions suggesting that an economy can be stimulated by revenues created in the private sector quickly fail the most basic of smell tests. Indeed, the only good that might come from Roubini’s proposals being passed is that so inimical are they to real economic growth, their certain failure will lead to a reassessment of the establishment consensus which suggests wealth redistribution actually causes people to work.

Back in the real world, economic growth and recovery will be the same as it ever was; the result of stable money values, low taxes on work effort, light regulation, and the liberty to trade one’s surplus with others irrespective of border. Any program that doesn’t promote those four basic inputs will harm, rather than stimulate our economy.

Thanks to the business malpractice of the Big Three, Michigan has been an economic basket case for years. We’re used to it. But if our well-deserved comeuppance is finally at hand, the rest of the nation should understand that it’s going to suffer a lot of collateral damage. This is not to say it shouldn’t be allowed to happen. Just a word to the wise: Be ready.

These three anachronistic companies now stand on the brink of collapse, threatening to take as many as 3 million jobs down with them. And since they have unsurprisingly come yet again to the federal government with hats in hand – hey, it’s been two whole months since their last federal bailout – Washington now faces a decision between propping up this suicidal economic model or letting a national economic calamity occur.

Some choice. The auto industry’s path to this point is a story that makes the sub-prime mortgage fiasco look like a case study in sound fiscal management.

In 1965, General Motors controlled 50 percent of the U.S. automotive market. Along with its domestic competitors, this corporate monstrosity collaborated with the United Auto Workers to make Michigan manufacturing workers the recipients of the highest wages, the richest benefits, the most generous work rules and the most lucrative retirement packages in history. When Michigan passed its Public Employee Relations Act that same year – the already-dominant force of unions in Michigan became codified into law and expanded to the public sector.

It was truly a team effort. Unions funded their preferred politicians with money collected through compulsory dues, then prevailed on them to pass laws making union membership more and more compulsory. The Big Three offered little resistance. Buying labor peace was always the priority for them, and if accepting life in a union-dominated state was the price they had to pay to keep the assembly lines humming, they would pay it.

Never was this more evident than in the 1980s, when the Big Three signed on to union contracts that committed them not only to soaring wages, but to legacy health care and retirement costs that promised to explode on them less than a generation later – just as vehicle sales were tanking and credit was becoming less accessible not only for their customers, but for the companies as well.

Today, even the sale of a new vehicle at retail cannot produce a profit for the Big Three. Their overhead is so exorbitant that a loss of $2,000 or more on a vehicle sale is simply a fact of life. And while they have cut costs by buying out workers and idling plants, it costs money to pay people not to work, and to maintain and pay taxes on plants that don’t produce anything. Even when they spend less, what they do spend becomes less productive.

Oh, and their sales are plummeting – down 25 percent compared to the same period last year, which was wretched in its own right. As a result, GM is burning through what little cash it has left at a rate of more than $1 billion a month. It is on track to run out of cash by the second half of 2009, and that’s a big deal because its credit rating is junk. It can’t borrow any more money. Its share of the $25 billion the industry is begging from Congress – assuming nothing else changes – would only keep it operating perhaps an extra year.

If ever three companies deserved to go out of business, it is these three. But it’s not that simple. Thousands of suppliers in a multi-tiered supply base depend on the Big Three for the bulk of their income. If the Big Three go, they go too. And while Michigan has more auto suppliers than any other state, an industry collapse would obliterate major manufacturers throughout the country. Those who have smartly diversified their customer base by doing business with transplants or customers in other industries would be in the best position to survive, but far too many suppliers have only talked about diversification while continuing to genuflect before the altar of the Big Three.

And so Michigan has imported its economic insanity throughout the nation. Even in low-tax, right-to-work (in other words, un-Michigan-like) states, jobs are in jeopardy because of an economic model that started in the Workers’ Paradise and caught plenty of otherwise sane companies in its snare.

Would you bail out this racket? With its bloated, unsustainable cost structure – the product of decades of economic denial by management, labor and political leaders alike – the auto industry led an entire state into a depression.

And if you did bail it out, you would surely insist on draconian conditions, no? The cancellation of all union and supplier contracts, new management, new business plans . . . at the very least? President-elect Obama, who is pushing the outgoing Bush Administration to give the automakers the aid, seems concerned only about insisting on the production of more fuel-efficient cars.

That will be a hell of a trick if the companies don’t even survive, and the quickest way to ensure that is not refuse their latest government bailout request, but to prop them up so they can keep doing what they’ve always done. What makes me think they would do that? What makes you think they wouldn’t? Ask any Big Three executive why the companies are in dire straits, all you’ll hear is a bemoaning of the current consumer credit crunch.

Exorbitant union contracts? Cars people don’t want? What are those?

The American auto industry has believed for generations that economic reality does not apply to it. It is too important and too big. One-time GM President Charles Wilson famously declared in the 1950s: “What’s good for General Motors is good for America.”

He really believed that, and so did a lot of other people – some of whom grew up to make Michigan labor laws and represent Michigan in Congress.

Today, what’s good for General Motors is bad for America. GM’s survival may be the only thing worse than its death – and that’s some trick.

Our "animal spirits," to borrow a phrase made famous by John Maynard Keynes, are weakening. George Akerlof and I have just written a book by the same name, but by the time Animal Spirits appears later this winter, the world economy may be even worse than it is now.

Nations everywhere are starting to implement aggressive stimulus and bailout packages. Yet the economic outlook still looks grim. The International Monetary Fund's latest forecast predicts that the world's advanced economies will contract 0.3% in 2009 - the first such shrinkage since the end of World War II.

Part of the difficulty of contending with a crisis of confidence is that it is hard to quantify confidence in the first place. The Conference Board Consumer Confidence Index in the United States, begun in 1967, fell in October to its lowest value ever. The latest Nielsen Global Consumer Confidence Index, which covers 52 countries, fell to 84, from 137 when it was launched in 2005.

But these surveys, which tabulate quick answers to simple questions, do not tell us how deeply held these opinions are, how new circumstances might change confidence, or what people will really do when they make important decisions in coming months or years.

This decline in confidence is fundamentally related to the chaos in the financial markets that started in 2007 and accelerated this September. The specter of collapsing financial institutions around the world, and desperate government bailouts to try to save them, has created a general sense of alarm.

Then there is the effect of memory on today's animal spirits. People know enough about the Great Depression to understand that there are parallels with today. Many know that interest rates on three-month US Treasury bills became slightly negative in September 2008 - for the first time since 1941. People are also aware that the stock market has not been this volatile since the Great Depression (with the single exception of October 1987). Beyond that, national leaders are defending extraordinary bailout measures by not-so-veiled comparisons to the Great Depression.

Animal spirits are not always shattered by extraordinary economic events. But then, not all economic convulsions are alike. For example, the October 19, 1987, stock market crash was the biggest one-day drop ever. The Standard & Poor's Composite fell by 20.5%, the FTSE 100 by 12.2%, and the Nikkei 225 by 14.9% the next day. The crisis spread around the world, but there was no recession. Instead, world stock markets recovered, creating a colossal bubble that peaked 13 years later, in 2000.

In a survey that I conducted immediately after the 1987 crash, I found that the biggest concern expressed by individual and institutional investors in the US was essentially that the stock market had been overpriced. After the crash corrected that problem, many people apparently did not feel there was much more to worry about. The only parallel to the Great Depression was the stock market drop itself. Moreover, many financial experts blamed the 1987 crash on a kind of programmed trading called "portfolio insurance," which most thought would stop.

But recent events do not carry such a rosy interpretation. The stunning magnitude of recent declines cannot be dismissed as a one-day anomaly caused by a technical trading glitch.

The week of October 3-10 was the worst stock market week in the US since the Great Depression, while Japan's stock market performed worse than it did in the worst week of the Asian financial crisis ten years ago. Similarly, Mexico's stock market performed about as badly as it did during the worst week of the Mexican financial crisis in 1995, and Argentina's stock market roughly matched the worst weekly drop during the country's financial crisis of 1997-2002. Extraordinary stock market volatility, both up and down, has continued since.

The current stimulus and bailout plans were hatched in reaction to that dreadful week. The G-7 countries announced a coordinated plan to fix the world economy on October 10, and that weekend the G-20 countries endorsed the plan. But stock markets were barely higher in early November. In China and India, they were lower.

The erosion of animal spirits feeds on itself. Immense market volatility serves only to reinforce people's sense that something is really wrong. A volatility feedback loop begins: the more volatility, the more people feel they must pay attention to the market, and hence the more erratic their trades.

Perhaps the saving grace in this situation is that animal spirits can and sometimes do change direction. Confidence is a psychological phenomenon, and can make seemingly capricious jumps up as well as down. The most promising prospect for a return of business confidence now would be some kind of public inspiration. In the US, President-elect Barack Obama seems to have the charisma to create this, and his status as the first minority president marks a major historical transition that might have great positive psychological impact in the US and around the world.

Whatever the near future holds the multitude of plans now being discussed to deal with this global crisis need to be judged with attention to the elusive and inexplicable effects they might have on confidence. The "animal spirits" that Keynes identified generations ago remain with us today.

Robert J. Shiller is Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC.

In other words, free-market capitalism is the best path to prosperity.

During a gloomy period of financial crisis, recession, big-government rescues, and ailing banks and industrial companies, Bush has provided a strong visionary dose of big-picture economic prosperity and optimism that can lead the U.S. and the rest of the world out of its economic doldrums.

Here’s another uplifting passage from Mr. Bush: “Free-market capitalism is far more than an economic theory. It is the engine of social mobility -- the highway to the American Dream. And it is what transformed America from a rugged frontier to the greatest economic power in history -- a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.”

Capping all this off, Bush said, “The triumph of free-market capitalism has been proven across time, geography, culture, and faith. And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.”

That reference to 60 years harkens back to the original post-WWII economic-rebuilding conference held in Bretton Woods, N.H., in July 1944. At that historic meeting, the U.S. and Britain led 170 delegates from around the world into a new era of free markets, free trade, and stable currencies. It was a conference of global coordination that broke down the isolationist and protectionist sentiments that upset the world order so badly during the prior 15 years.

Ultimately, the free-market system forged at Bretton Woods, which was in no small way predicated on economic prosperity, led to a triumph of Western values over Soviet state socialism. And it was President Reagan -- along with his friend, British Prime Minister Margaret Thatcher -- who applied the final blow to the now-defunct Soviet system with his rejuvenation of free-market capitalism.

So what George W. Bush seems to be saying is this: Do not discard that triumphal system just because we’ve had a rough year in the financial markets and the economy.

In a few weeks Barack Obama will inherit the mantle of the capitalist system. What will he do with this responsibility? That’s the question being asked everywhere.

Since the election, and up until President Bush’s important G-20 speech, stock markets sold off nearly 15 percent. Investors want to know if economic rewards will be encouraged or penalized. Will trade remain open and free? Will we maintain competitive businesses that can compete worldwide? Or will we resort to the protection of ailing or failed businesses?

Will the U.S. lurch toward the semi-socialism of Old Europe? Or will we stay with free-market capitalism? Will we expand the nanny-state economy? Or will we keep the door wide open to entrepreneurial spirit and gales of creative destruction?

Investors want to know which way President-elect Obama is going to go. Might he reach back to the Democratic pro-growth supply-side policies of John F. Kennedy’s tax cuts, free trade, and strong dollar? Will he opt for Bill Clinton’s free-trade and strong-dollar policies, or even his capital-gains tax cut? Or will he fall back to the hopeless government tinkering of Jimmy Carter or the welfare-statism of Lyndon Johnson?

I’m keeping an open mind on Mr. Obama during this post-election honeymoon period. After all, he stole the tax-cut issue from Sen. McCain during the election. And surely he knows the conservative red states that joined his campaign for change didn’t vote for a leftward lurch to socialism lite.

Mr. Obama has a huge opportunity and an outsized responsibility to mend and revive the economy. It may be too much to ask, but perhaps he will give President Bush’s marvelous speech a close read. There is much wisdom there. And there is no iron-clad reason why a Democrat can’t adopt the economic-growth model that has worked so well and so long for this country.

The seepage of government into everywhere is, we are assured, to be temporary and nonpolitical. Well.

Probably as temporary as New York City's rent controls, which were born as emergency responses to the Second World War and are still distorting the city's housing market. The Depression, which FDR failed to end but which Japan's attack on Pearl Harbor did end, was the excuse for agriculture subsidies that have lived past three score years and 10.

The distribution of a trillion dollars by a political institution -- the federal government -- will be nonpolitical? How could it be? Either markets allocate resources, or government -- meaning politics -- allocates them. Now that distrust of markets is high, Americans are supposed to believe that the institution they trust least -- Congress -- will pony up $1 trillion and then passively recede, never putting its 10 thumbs, like a manic Jack Horner, into the pie? Surely Congress will direct the executive branch to show compassion for this, that and the other industry. And it will mandate "socially responsible" spending -- an infinitely elastic term -- by the favored companies.

Detroit has not yet started spending the $25 billion that Congress has approved but already is, like Oliver Twist, holding out its porridge bowl and saying, "Please, sir, I want some more."

McCain and Palin, plucky foes of spreading the wealth, must have known that such spreading is most of what Washington does. Here, the Constitution is an afterthought; the supreme law of the land is the principle of concentrated benefits and dispersed costs. Sugar import quotas cost the American people approximately $2 billion a year, but that sum is siphoned from 300 million consumers in small, hidden increments that are not noticed. The few thousand sugar producers on whom billions are thereby conferred do notice and are grateful to the government that bilks the many for the enrichment of the few.

Conservatives rightly think, or once did, that much, indeed most, government spreading of wealth is economically destructive and morally dubious -- destructive because, by directing capital to suboptimum uses, it slows wealth creation; morally dubious because the wealth being spread belongs to those who created it, not government. But if conservatives call all such spreading by government "socialism," that becomes a classification that no longer classifies: It includes almost everything, including the refundable tax credit on which McCain's health-care plan depended.

Hyperbole is not harmless; careless language bewitches the speaker's intelligence. And falsely shouting "socialism!" in a crowded theater such as Washington causes an epidemic of yawning. This is the only major industrial society that has never had a large socialist party ideologically, meaning candidly, committed to redistribution of wealth. This is partly because Americans are an aspirational, not an envious, people. It is also because the socialism we do have is the surreptitious socialism of the strong, e.g., sugar producers represented by their Washington hirelings.

In America, socialism is un-American. Instead, Americans merely do rent-seeking -- bending government for the benefit of private factions. The difference is in degree, including the degree of candor. The rehabilitation of conservatism cannot begin until conservatives are candid about their complicity in what government has become.

As for the president-elect, he promises to change Washington. He will, by making matters worse. He will intensify rent-seeking by finding new ways -- this will not be easy -- to expand, even more than the current administration has, government's influence on spreading the wealth around.

While some details remain to be worked out, Fannie Mae will acquire all the assets of the Ford Motor Company while Freddie Mac will do the same for General Motors Corp., pouring the full faith and credit of the US Treasury into these backbones of American Manufacturing.

Ninety-five percent of homeowners facing foreclosure will be allowed to stay in their primary residence rent free for a renewable four year term provided they divert at least 80% of their current mortgage payments toward the purchase of two new American cars, one of which must get no less than 35 miles to a gallon of corn ethanol and the other of which must be a plug-in hybrid that can travel no more than 40 miles on a full charge. In order to qualify, cars must be built in UAW-certified plants that operate fully staffed Job Banks while associated auto loans must be serviced by banks that have accepted TARP funding.

Holders of CDO bonds whose mortgage service revenues have been diverted to car payments will instead be compensated with government issued WDN certificates that can be used to either pay outstanding federal tax liabilities, expected to increase dramatically to help fund the program, or make campaign contributions that will be exempt from McCain-Feingold limits. Goldman Sachs quickly announced the creation of a new exchange where WDN certificates, futures, and derivatives can be bought and sold while Starbucks offered a free cup of coffee to anyone who donates a WDN certificate to any Non Governmental Organization (NGO) that promises to "end badness in the world."

As news of the program's passage spread, jubilation erupted across a confused and weary land. "Who says we don't get the government we deserve?" said Joe the Plumber, out on bail from charges of plunging without a license. "See how effective our public servants can be when they put aside their partisan differences and work for the common good," added Paris Hilton, whose name is rumored to be in contention for ambassador to Iran.

In separate news, Chrysler Corporation has filed for Chapter 7 bankruptcy. "We cannot allow greedy hedge fund managers to profit from the misery of others," mumbled Rep. Barney Frank. Executives from Cerberus spotted leaving Mr. Frank's office were pelted with rotten fruit and quiche tossed by an angry mob of NPR listeners that had gathered on the Capitol steps to protest excessive CEO compensation.'

They were mollified by Mr. Frank's promise that compensation for any executive whose company might benefit from WDN would be strictly limited to that of the lowest paid public school teacher in their district.

As night fell on Washington and the news media interviewed itself for the twenty-seventh time, right-minded analysts agreed that the era of big government, formerly believed to have ended, is alive and well.

Bands of energized youths camping out for the inauguration warmed their hands over trash cans burning documents bearing a striking resemblance to the Constitution, though no one could be certain as few had ever seen much less read the antiquated document.

"We are all French now," wheezed a recently laid off CATO Institute staffer, too tired and demoralized to fight a losing battle against Change. "Nothing lasts forever."

3. Repeal the Corporate Average Fuel Economy (CAFE) law, which prevents U.S. companies from specializing in the large vehicles that they can make and sell at a profit.

4. Amend the Endangered Species Act and the Clean Air Act to prevent these laws from being used to regulate carbon dioxide emissions.

5. Make it illegal for companies to offer benefit plans that create unfunded liabilities (as GM’s promises of health care for retirees did).

Even if all five of these measures were passed, GM would still have to go through Chapter 11 bankruptcy to get its cost structure in line and rationalize its dealer networks. However, the capital markets would almost certainly provide the “Debtor in Possession” financing required for this.

Baring these drastic actions, GM cannot be saved. The best that the “bailout” plans currently being proposed could do is to turn GM into “Amtrak on rubber tires”, a UAW-staffed, taxpayer-subsidized museum of mid-20th-century American business glory.

This sounds harsh, but let’s look at the facts. As a company, GM’s peak was in 1965-1966, when it had more than 50% of the total U.S. vehicle market (vs. around 20% today). This period also just happens to have been the peak of real American prosperity. In January, 1966, the “real” Dow Jones Industrial Average, which is the DJIA divided by the market price of gold, peaked at 28.00. After that, the Bretton Woods monetary system started breaking down and the government started raising taxes. The U.S. economy began to decline, and GM declined with it. Today, despite 42 years of capital investment on the part of the Dow companies, the real DJIA is less than 12.00. “Engine Charlie” Wilson, then GM’s CEO, was prophetic when he said in 1953, “What is good for the United States is good for General Motors, and vice-versa.”

The post-Bretton-Woods unstable dollar has been disastrous for GM. The automobile industry is extremely capital-intensive, and inflation raised the real cost of capital in the U.S. vs. Japan. Also, it can take as long as 6 years to develop a new vehicle. In the past six years, the price of gasoline in the U.S. has gone from under $1.50 per gallon to over $4.00/gallon and then back to $2.00/gallon. All of this was the result of the unstable dollar. Although the price fluctuations were not “real”, they had a huge impact upon GM’s sales and product development.

In the mid-1960s, GM’s costs were lower than those of its competitors, who, for practical purposes, were just Ford and Chrysler. This allowed GM to offer more car for the money while still earning higher profit margins. The spectacular styling of the 1965 GM big cars (Chevrolet Impala, etc.), which propelled GM to its market share peak, was made possible by the use of curved side glass. This was more expensive than the flat side glass used by Ford and Chrysler on their 1965 models, but GM could afford to offer it.

Japanese imports got their foothold in the U.S. when the collapse of Bretton Woods in 1971 led to two inflation-driven oil price bubbles, in 1973-1974 and 1979-1980. Americans bought Japanese cars to get higher fuel economy and discovered that they also had much higher quality. Even more worrisome for GM, the Japanese companies, which were not organized by the UAW, had lower costs.

In the 1970s, GM needed to either fight the UAW to the death to get its costs down, or to abandon the small car market and focus on large vehicles. It lacked the courage to do the former, and the Corporate Average Fuel Economy (CAFE) law, which was passed in 1975, prevented it from doing the latter.

It is difficult to overstate the damage that CAFE has done to GM over the years. The entire purpose of CAFE is to force companies like GM to do something other than build and sell the vehicles that would earn them the greatest profit. Otherwise, there would be no point to the law.

CAFE has bled GM of tens of billions of dollars in profits over the years. If they had all of those dollars in the bank today, they would not be on the brink of bankruptcy. CAFE forced GM to build millions of small cars and sell them at a loss. To make matters worse, CAFE made it illegal for GM to exploit its single most profitable brand, Cadillac.

Once a brand is established in the public’s mind, it is impossible to change its image. A Cadillac is either the biggest, flashiest vehicle available, or it is nothing. The iconic Cadillac is the 1959 model, a land leviathan with huge fins and bullet taillights.

Small Cadillacs don’t sell. The only really profitable Cadillac in recent years has been the Escalade, which is the biggest, flashiest vehicle available. People who can afford Cadillacs can afford the gasoline to run them. CAFE pushed these customers into the arms of Mercedes and Lexus and cost GM billions of dollars in lost profits.

So, Congress, please don’t put GM on life support with a feeding tube full of taxpayer dollars. If you undo all of the things you did to put GM on its deathbed in the first place (see the list above), the private markets will finance GM’s recovery. If you are not willing to do that, please just let GM die a quick and merciful death.

Now, when the Democrat-dominated 111th Congress begins in January, and Rangel resumes his chairmanship of the panel from which all tax legislation must originate, he will be dealing with a president who has promised to intensify the war in Afghanistan, reduce corporate taxes and undertake a line-by-line search for things to cut out of the federal budget.

The Congress of which he is a key leader will also be faced with the continued management of a financial crisis of historic proportions. So isn't it funny that in the midst of such a serious emergency, when congressmen are worrying about going down in the history books as the next Herbert Hoover, Sen. Smoot or Rep. Hawley, even inner-city liberals will turn to that tried-and-true economic medicine — allowing businesses to keep more of their own money.

Interviewed on Bloomberg Television's "Money and Politics," Rangel said that he would be changing the proposal he has backed for more than a year, which would have reduced the corporate tax rate to 30.5%, and will now propose to cut it even more deeply — to 28% — in line with President-elect Obama's economic agenda.

When it comes to corporate taxation, the U.S. is at a severe disadvantage to the rest of the world. The only industrialized nation with a higher marginal corporate income tax rate than America is Japan. What's more, state taxes can bring the actual marginal rate up to 39% for corporations.

Bruce Bartlett, an architect of the Reagan tax cuts and deputy assistant secretary for economic policy at the Treasury Department in the George H.W. Bush administration, noted in his 2006 book, "Impostor," that "since at least the 1930s, most economists have recognized that the corporate income tax is essentially a double tax that raises the cost of capital and has other undesirable economic effects."

As Bartlett explained it, "When income is earned by a corporation, it is taxed and then the same income is taxed again when paid out to its owners, the shareholders, in the form of dividends."

As long ago as 1992, the Treasury Department issued a study on how to integrate corporate and individual income taxes into one tax system. But Washington has never mustered the political will to accomplish the task and thus end the harmfulness of double taxation.

Rangel has proposed repealing the domestic production deduction and other tax breaks to go in hand with the corporate rate reduction. Unfortunately, the chief tax writer has also floated the idea of making private equity firms pay ordinary income taxes instead of the lower capital gains rate on the "carried interest" they charge their clients — perhaps 39.6%, if Obama gets his way on increasing the top individual tax rate, along with a possible 4% surcharge that Rangel has talked up.

That would be a fateful blunder; private equity firms are experts at taking ailing public companies, converting them to private entities in complex transactions, then performing the kind of drastic surgery needed to bring them back to health so they can return to a growth track and provide Americans with new jobs. Sticking it to those who perform this invaluable service is the last thing our economy needs in this time of crisis.

An Obama-Rangel alliance to reduce corporate taxes would be a welcome surprise for American business. If they really want to see their names engraved in gold in economic lore, however, they should set their sights higher and end double taxation by abolishing the corporate income tax and integrating the two tax systems.

That would be the kind of change that has eluded Republicans and Democrats alike for decades.

Across the Atlantic in the United States, something similar was at work. Decrying the consumer culture which prevailed during his presidency, President Jimmy Carter noted that “too many of us now tend to worship self-indulgence and consumption.” But with the dollar in freefall alongside high capital-gains rates, Americans were understandably consuming at a manic pace. Fully aware that inflation and taxes would erode any investment profits, Americans had little incentive to save, and the Carter economy’s actual health was much worse than what unreliable GDP numbers suggested at the time.

To the supply-side revolutionaries of the late ‘70s who so expertly changed the economic debate, the economic situations in England and the U.S. were no surprise at all. Indeed, supply-side economics was never about “putting money in people’s pockets” as George W. Bush once stated, nor was it ever about consumption.

Instead, supply-siders resumed the arguments made by classical liberals such as Adam Smith and Jean-Baptiste Say in the 18th and 19th centuries. Both recognized that an economy never lacks consumption so long as individuals possess incentives to produce.

Productive work effort in the classical liberal model was what constituted economic growth, and as such, it was essential to reduce the tax penalties on work and investment so that the efforts of enterprising individuals would be met with intrepid capital eager to fund economy-enhancing innovations.

So while conventional economic thinkers see rampant consumption and “stimulus” as something that accrues to our economic health, supply-siders then and now understood that heavy consumption at the expense of saving could only last so long. Eventually the prodigal consumer runs out of capital.

Conversely, the prodigious saver, far from harming the economy, actually facilitates economic growth for those savings serving as capital for existing and new business concepts. As Adam Smith noted, savers are society’s ultimate benefactors. They are because in any economy products are traded for products. Savings fund economic creativity that leads to economic productivity by individuals eager to exchange their surplus for that of others. In short, we’ll always have consumption so long as the economy is growing.

All of which brings us to Treasury Secretary Henry Paulson’s announcement last week that the latest version of Treasury’s $700 billion Troubled Asset Relief Program will focus on the consumer. In an administration that has sought to deify the presidency of Ronald Reagan and the supply-side revolution that he was often associated with, Paulson’s latest move speaks to an administration that either never understood supply-side theory, or understood it but views it as unworthy of emulation. With regard to Paulson, we’re all Keynesians now, and supply-side economics can drop dead.

Paulson’s reasons for “aiding” the consumer have to do with his view that consumer finance “is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt.” As such, his plan according to a Wall Street Journal account is to use TARP money to “increase the availability of student loans, auto loans and credit cards.” Adam Smith is doubtless spinning in his grave.

Indeed, if we try to forget for a moment that the proliferation of federally-backed student loans has necessitated more student loan money for driving up education costs, Paulson’s newest attempt to “fix” the economy is surely inimical to our economic health. In times of economic distress, when capital is in short supply, the last thing an economy needs is for more capital to be consumed as opposed to being supplied to future entrepreneurs.

Indeed, in times of economic weakness the best economic “stimulant” absent a stabilized dollar or tax cuts is paradoxically the very consumer pullback that Paulson and his minions are trying to avoid. That is so because when individuals choose to save rather than consume, their capital, far from vanishing, funds the growth of job-creating business concepts. To the extent that Paulson’s activities foist more credit on an already tapped consumer, there will be even less capital available for tomorrow’s ideas. Recovery will be pushed back even further.

So while many fear the looming presidential transition that perhaps foretells an even greater lurch toward statism, it would be hard to find in history a presidential administration more interventionist than this one. At this point, GOP partisans should be giddily counting the days until Paulson et al move on. The latter have overseen an impressive destruction of the GOP brand, and as evidenced by Paulson’s latest policy maneuvers, their departure will be a positive for limiting any further damage.

As for supply-side economics, conventional historians will sadly use George W. Bush’s presidency as evidence that classical thinking is a hoax. But in truth, other than the 2003 tax cuts that were blunted by dollar debasement and heavy spending that are merely other forms of taxation, the Bush presidency had very little to do with supply-side thought. In short, historians will critique a classical liberal administration that never was.

Obama is backing a plan to pump $50 billion into the big American automakers, while also establishing "a czar or board to oversee the companies"—call it Gosplan—which will supervise "a restructuring of the auto industry." That's exactly what Detroit needs to recover: the benefit of government central planning.

In essence, this is a plan for nationalization of the American auto industry under a new government-appointed board of directors who will supposedly tell the Big Three how to make a profit again.

But of course Detroit will never recover under this plan, because its whole purpose is to avoid the one step actually necessary to make the automakers profitable: breaking the hold of the bloated unions. Let's be clear on that. The purpose of the bailout is not to avoid the destruction of automobile production in the US. Plenty of automobiles are being produced in America by Honda and Toyota and other automakers—at non-unionized shops. And if the Big Three were to go bankrupt, they would likely be bought out, or at least their most valuable pieces would be scooped up by new owners. But if GM goes into bankruptcy, its contracts with the unions would likely be thrown out—you can't have a contract with a defunct firm—and the new owners would be able to negotiate new contracts from a position of strength. Accept our terms, they would be able to say, or you will all be out of work permanently.

That is what a bailout is really meant to avoid: anything that would break the power of the unions. This is not a bailout for GM. It is a bailout for the UAW.

Here is the key phrase that sums up the outlook behind the bailout: Susan Helper, a professor of "regional economic development" at Case Western Reserve University tells the New York Times "From a social point of view, even if GM is not providing a return on investment, it is still providing a lot of good jobs."

If this bailout goes through, GM will get a lot of opportunities to do things that don't provide a return on investment but are considered desirable "from a social point of view" in Washington, DC. In fact, while the immediate motive for the bailout is to seize the Big Three in the name of the proletariat—the auto workers—there are also plans to seize the companies in the name of the planet.

A recent LA Times op-ed complained that:

the US automotive industry has been on the wrong side of almost every environmental, social, and safety issue since the 1960s….

If the US government—on behalf of the people—is going to spend considerable sums of public money and incur public debt to keep these institutions alive, let's insist on returns that benefit society as a whole, not merely Big Three shareholders, management, and employees.

What might these public benefits be? Well, for one, isn't it time for Detroit to turn out a car that gets at least 100 miles per gallon—and to do it in three years?

If the Old Left's goal is to save the unions, the New Left's goal is a kind of economic coup d'etat in which the environmentalists take over their hated enemy, the auto industry, and convert it into a new conduit for "green economy" subsidies."

This is going to be cloaked in claims about 100-mile-per-gallon cars and how they are going to be good for the economy. If the Soviet central planners had Trofim Lysenko, we have Jennifer Granholm. In a recent op-ed, the governor of Michigan claimed that "The US auto industry is the sector that will lead the way to energy independence. How? The car you drive will soon be the storage unit for all your energy needs. Your home, your car, your appliances can all be powered through the advanced battery that will sit inside your plug-in electric vehicle." Never mind that Detroit has been working for decades on this alleged super-battery breakthrough—without success. More fundamentally, someone needs to remind the governor that batteries are used to store energy, not to generate it.

The technological reality behind these preposterous claims is the Chevy Volt, which can travel only 40 miles before conking out, at which point it needs to charge for six hours. And the giant lithium ion battery it uses only lasts for 5 to 7 years before it needs to be replaced. For all of this inconvenience, consumers can expect to pay as much as $40,000 per car—at which price Chevy still will not make a profit on it.

That is the future the auto bailout advocates are selling us. Their rationalizations may be new, but they are bringing us back to the same place. They are scheming to transform the Big Three into permanently government-subsidized, government-run organizations that employ an inefficient and unmotivated workforce to produce small, underpowered cars at a financial loss.

While the government is busy restructuring GM, maybe they should consider renaming it "Trabant."

There is a lot of navel-gazing going on right now in conservative circles about how the Republicans can recover from last week's election loss. But rather than just talking, the Republicans should be doing something: they should take the lead in opposing the nationalization of the auto industry and in opposing the whole bailout culture that the Bush administration, the Democratic Congress, and the new president are trying to create.

The question, "Did you vote for the bailout?" should become, to Republicans, what the question "Did you vote for the Iraq war?" is to Democrats. Support for the bailout should become a stigma against any Republican politician within his own party, a decision he has to repudiate and apologize for—and opposition to the bailout should become a prerequisite for any Republican who wants to hold a leadership position.

The Republican Party stands for free markets in the minds of the public—so maybe they should try standing for free markets in reality. If they do so, they may just save us from the grey, dismal future Washington's new central planners have in store for us.

The Somali pirates who launched the attack on a Saudi-flagged carrier hijacked the largest vessel ever, taking it 480 miles from Mogadishu, the farthest it had ever been from a coast. Obviously it was no crime of opportunity, but the act of an organized criminal syndicate now strong enough to threaten global energy security.

Loss of the MT Sirius Star, with its cargo of 2 million barrels of oil, took more than a quarter of Saudi Arabia's daily oil production off the market. It was part of the 4% of global oil exports that transport through the Gulf of Aden to the Red Sea. Not only is the open sea unsafe for transport, but two ocean routes — through the Suez, and around the Cape of Good Hope, are now both dangerous.

A picture of what is happening is important: Somalia is a failed state that's become a pirate paradise. The 88 attacks off its coast and the Gulf of Aden in 2008 account for a third of the world's sea hijackings. Unarmed tankers and cargo ships are easy pickings, and with no government to turn to for help, shipping companies pay ransoms to recover their ships and kidnapped crewmen.

Of course when a ransom is paid, a new hijacking takes place afterward. The New York Times reports that Somali officials say that 2008 is a record year for pirate profits, with ransoms bringing in $50 million so far. The attacks have grown bolder — a Ukrainian weapons ship was seized just before the supertanker was taken.

Clearly, anarchy is fueling piracy and ransoms are empowering pirates. If they are to be stopped, coordinated action from the international community, the kind used to break terror and drug-trafficking groups, is critical, and every nation must be a partner.

First, the Gulf states that produce oil should take a more visible role in fighting this threat to their livelihoods. They already have good domestic operations against terrorists who threaten their oil installations, but they will need to expand to maritime powers.

Meanwhile, shipping companies must help too. They will have to accept guarded patrol runs. The French and U.S. navies have already begun doing this.

More importantly, the paying of ransoms has to end. The fact that no U.S. ships have been attacked in that area probably has much to do with U.S. policy to never negotiate with terrorists.

Third, ships will probably have to be armed, which can create danger on energy carriers but could be achieved through noncombustible devices such as water cannons. Arming ships will raise costs, but it will reduce attacks, ransoms and insurance rates.

Fourth, as hopeless as it sounds, Somalia needs nation-building. Its failed-state conditions are the root of the piracy. The United Nations, which runs the government there, needs to do more to create alternatives to piracy.

Halting piracy is important because it is a significant risk to the world's energy. Not only is the global crude supply vulnerable, but pirates can create "five Hiroshimas" if they get hold of a liquefied natural gas tanker, an expert quoted by the Los Angeles Times said. They can also shut down sea lanes.

The pirate organizations grow stronger with every attack and can eventually take over a state. From there, the ground is laid for worse, with terror organizations and drug traffickers finding a welcome lair. Unless this is stopped, it will multiply the threat.

The tax-cutting binge is taking place in what some have called “Old Europe.” France, Germany, Italy, and Spain have cut their top personal income tax rates since 2003. Germany, Italy, Spain and the U.K., meanwhile, have trimmed corporate tax rates, too, in just the past year.

Driving the Western European governments is aggressive tax policy in New Europe, that is, Eastern European countries, which are competing for workers and investment. Many of these countries had the opportunity to design their own tax systems after the fall of the Soviet Union and they have often opted for tax schemes that are simpler than the U.S. or Western European systems. Many feature only a few tax brackets and a few are flat tax schemes. Bulgaria has a new flat tax rate of 10 percent, down from a top tax rate of 29 percent in 2004. Estonia has cut its flat tax rate to 21 percent from 26 percent, while the Slovak Republic has trimmed its top rate from 38 percent to a flat tax rate of 19 percent. Romania has eliminated its top rate of 40 percent and gone to a flat tax of 16 percent.

In Asia-Pacific, Hong Kong’s low taxes (top rate, 16 percent) have continued to make it a magnet for both people and money and prompted tax cuts in other countries. Australia cut its top income tax rate two percentage points to 45 percent to try and lure back talent fleeing to Hong Kong and Singapore, but Australia has a long way to go to be competitive. Singapore has countered by slashing its top rate to 20 percent from 22 percent.

“It is common to hear from foreign workers that once families have become accustomed to the huge increase in spending and saving power that low tax rates provide, it can be very difficult to justify going home,” says KPMG’s Rosheen Garnon of the tax battle in the Pacific.

The tax cutting of the past few years has eroded the United States’ competitive position. One measure of where the U.S. is competitively: According to the KPMG study, the average top personal income tax rate worldwide have fallen to 28.8 percent today, from 31.3 percent in 2003, while our top rate remains at 35 percent. On corporate taxes, the U.S. now ranks second highest within the OECD, below just Japan. We sport a top rate of 35 percent, compared to an average rate of 26.6 percent among the OECD 30. However, many U.S. states also have their own corporate income taxes which they layer on top of the federal rate, making the combined tax in many states among the highest in the developed world. And we have obstinately ignored a worldwide trend. As the World Bank writes in its publication, Paying Taxes 2009, “Reducing corporate taxes has been the most popular reform” of tax codes around the world in the past four years.

Although there was plenty of talk about U.S. tax policy in the presidential campaign, little of it seemed to have anything to do with international competitiveness. Perhaps we simply believe that the U.S. is too attractive a place to worry about competing for talent and capital with the rest of the world. Or maybe we cling to outmoded notions about the prevalence of the European welfare state and haven’t noticed how much and how rapidly tax policy is changing elsewhere.

Perhaps it is time for a little bit of reevaluation. During the presidential campaign, Obama justified his plans to raise taxes on those earning more than $250,000 a year on the grounds that these households needed to “pay their fair share.” He never explained why he didn’t think these folks are paying a fair share in our progressive income tax system. But perhaps someone should point him to OECD data on the progressiveness of household taxes (that is, income and payroll taxes) around the world.

According to the OECD calculations, in the U.S., the top 10 percent of households earn one third of the country’s total income and pay 45 percent of all household taxes. That’s the highest ratio of taxes-to-income among OECD members. In France, for instance, the top 10 percent earn a quarter of national income and pay 28 percent of all taxes; in Sweden they earn 26.6 percent and pay 26.7 percent of all taxes; in Canada, it’s 29 percent of earnings and 35 percent of all taxes.

Most surveys taken before the presidential election showed that residents of foreign countries in the developed world, particularly in Western Europe, heavily favored Obama and would have voted for him if they had been American citizens. Considering how uncompetitive America is becoming on taxes and the direction Obama would take us, I think I now understand why.

Of course, it wasn’t painless. So many of us learned to save often, back up etc. and thus reduce the pain of the inevitable “blue screen of death” or other vagaries of computer-user life. While some of us had tech support hanging around to bail us out from really terrible happenings, most of us learned to slog it out on our own and deal with it.

Today we spell reset “T-A-R-P.” Somehow between then and now we have decided that the reset button should be part of non-machinery things. So, if you invest in a CDO and it goes bust, hit the old TARP button and get your money back. 401K in the soup? No problem, hit the TARP button. Negotiate a bad deal with the unions and make your car company uncompetitive? No problem: hit the TARP button and get a do over.

Pressing the reset button on your computer has instant effect but it is rarely without consequences. But it gave us a “safety net” mentality; if we make a mistake and fail it will be annoying but not deadly. Unfortunately this mentality has crossed over into our financial thinking from the individual investor, through the corporate CEO right up to our representatives in government at the local, state and federal level. This allowed us to take completely and obviously nonsensical risks which got us into the economic predicament that we find ourselves in today.

By my calculations at least $1 trillion dollars has been thrown at the problem so far. No one seems to know when we will stop going to the well for more. One trillion bucks is about the annual income of the top 1% of US tax payers. So if we tax them at 100% for a year we perhaps might be able to pay for the reset button but that will certainly not cover the incredible deficits looming in our future. So the U.S. government will need to either seize assets (as Argentina did with their 401Ks) or let individuals, companies and governments deal with their own reset issues and take the lumps for the mistakes they made.

Yes Virginia, there is no Santa Claus, free lunch or painless reset button.

But all this brings up a whole new problem in American finance: How are we going to transport and deliver trillions of dollars of new government money? It’s not an easy task. We’ve moved beyond show me the money. This is throw me the money. And shovels alone won’t do.

We’ll need to convert Caterpillar earth movers into money movers. We’ll need new streamlined helicopter fleets to drop money from the sky. We’ll need a trucking armada and full use of the railroads. And we’ll need an army of smaller trucks and SUVs to reach folks in the off-road areas. And let’s not forget FedEx and UPS -- we’ll need them to make sure the money arrives on time.

We may even need high-level planners at the Department of Transportation to help coordinate this vexing money-delivery problem. Sending out trillions of dollars may sound great to your average liberal Congress member. But this will not be easy. Perhaps the transitioning Obama administration can designate a Transportation Monetary Tsar. These logistical realities must be dealt with.

Or maybe there’s a better idea: Maybe we take Mr. Paulson at his word but go one step further. Let’s stop any new TARP money -- period. Enough is enough. The TARP has already done some good. Banks have more capital. Credit spreads in the money markets are narrowing. And there even are signs that business and consumer loans are flowing once again. So let’s cap the TARP -- or tarp the TARP.

The new congressional Keynesians believe government can spend us into prosperity. They’re wrong. Everything we have learned in the last four decades tells us that governments don’t create permanent new jobs or capital investment. In fact, the more we spend, the more we’ll have to raise tax rates. And that depresses growth. Europe went down this road and failed. So did Latin America and parts of Asia before they wised up.

And for some reason no one in Washington is talking about cutting tax rates, which would strengthen incentives to work, invest, and take new business risks. We should be making it pay more after tax for entrepreneurial activity of all kinds. How about this: Let’s get back on the path of free-market capitalism.

Even at the G-20 meeting in Washington this past weekend, all one heard was “global fiscal stimulus” -- or more spending on a worldwide scale to fight recession. It won’t work. It never has. Hundreds of academic studies over the past 25 years show clearly that countries that spend more, grow less; but that nations that tax less, grow more.

Why these lessons have been forgotten is beyond me. We have to restore market discipline and personal accountability. We should reward the economic good, but punish the bad. Instead we have launched a demoralizing government-spending nymphomania.

Incidentally, all this talk of big-government bailouts and a never-ending flow of government spending has disheartened the stock market, which is now down five of the past seven days. Since the November 4 election, the Dow is off 15 percent, or more than 1,400 points.

All this shows why, like the grounds crew at a baseball stadium on a rainy evening, we need to roll out the tarpaulin in order to preserve the field. To safeguard today’s economic field, it’s time to tarp the TARP. Let’s stop right here at $350 billion before everyone in the country demands a piece of the new TARP action. At the same time, let’s cut taxes to grow the economy. Slash the corporate tax rate. Reduce personal rates across-the-board. Promote investment with a lower capital-gains tax and a lower estate tax. Let’s restore the incentive model of economic growth.

Current political trends in Washington are gonna push us off some left-wing economic cliff. Instead, let’s have some sanity. It’s time for a reality check about what works and what doesn’t in fighting recession and promoting long-term economic growth.

I say tarp the TARP.

Not long ago, Alitalia was one of the largest airline companies in the world. Today it is a shadow of its former self, having burned massive amounts of taxpayer money before finally entering bankruptcy with few assets remaining. The principal culprit of this debacle was the Italian government. Trying to avoid the political pain a bankruptcy would have caused, the government continued providing subsidised financing to the money-losing airline, delaying the necessary restructuring. Not only was a gigantic waste of taxpayers’ money, but it was a death sentence for the very company it wanted to save. Postponing the day of reckoning weakened Alitalia’s competitive position, making it lose market share it will never regain as a reorganised company.

GM Is Broke, How To Fix It?

General Motors is quickly going down the same path. There is no doubt that it needs a serious restructuring. It burned through $9 billion of cash in the first 9 months of 2008. It has a labor cost 50% higher than U.S.-based Toyota plants, and it produces cars nobody wants. It is saddled with massive pension and healthcare obligations and it is essentially insolvent: its total liabilities are more than 50% greater than the book value of its assets.

Critically, GM’s position on the verge of bankruptcy is not because of the severity of the current financial and economic crisis. The current crisis is simply the proverbial straw that breaks the camel’s back. Without the crisis, the camel would not have lasted long anyway.

Bailout: Cash for a Drug Addict

If the US government provides GM with a $25 billion loan that allows it to continue operating under current conditions for another year or two, the money would simply be wasted and the problem postponed. GM would still be completely unable to survive in the long term. We are very sympathetic towards the pain of the hundreds of thousands of workers whose jobs are at stake. It is precisely because we are concerned about their long term welfare that we oppose a bailout. Throwing money at a drug addict only enables the addict to continue abusing drugs and ultimately shortens his life. Similarly, government money aimed at a company that needs restructuring enables it to avoid taking responsibility of its future, condemning it to a certain death.

A Debt for Equity Swap Won’t Work

Unfortunately, in this case the transformation of part of the debt into equity, as proposed by one of us for banks, is not a solution either. GM’s problem is not a short-term liquidity crisis. A debt-for-equity swap would provide temporary relief from GM’s short term obligations, but at the cost of continuing the bleeding and delaying the restructuring. GM would just continue to run down the value of its assets. The only difference with respect to a government bailout would be that investor money instead of taxpayer money would be wasted.

Chapter 11 Is the Way Forward

We believe that a Chapter 11 bankruptcy filing for GM is the only possible solution. However, we recognise that in the current environment, there are several likely inefficiencies associated with the bankruptcy process. In particular, if we do nothing and wait for GM to file for bankruptcy, which would likely happen in a month or so, we would risk a bad outcome of the proceedings, namely an inefficient liquidation of the company and a substantial amount of social disruption from the sudden loss of jobs. We therefore propose that the government oversee a prepackaged bankruptcy for GM that would give the company the restructuring it badly needs and avoid inefficient liquidation. To be successful, this restructuring requires several elements.

Beware Chapter 11 without DIP Financing

First, financing must be available during the restructuring. In normal times, this debtor-in-possession (DIP) financing would typically be provided by financial institutions. However, obtaining DIP in the current environment is a risky business. The market for the provision of DIP is dominated by a few players, and it is not clear how many of them are willing to lend now. JP Morgan, for instance, has several billion of DIP financing tied up with Delphi, GM’s main supplier of parts, which has been in bankruptcy since 2005. It is doubtful that JP Morgan will be willing or able to double up its exposure to the automobile industry. At the same time, GE Capital and Citigroup, who provided the DIP finance for the Chapter 11 bankruptcy of United Airlines, are unlikely to become the financiers of GM because they have problems of their own. Without DIP financing, however, Chapter 11 would lead immediately to liquidation — not a liquidation driven by market forces, but a firesale due to the current dislocation of the financial markets.

In this case, given the frictions on the credit market, it would be justified for the government to provide DIP financing. This loan would be very different from the one proposed by GM executives and unions. By being senior to all the existing debt it would be relatively safe for the government.

Energising Restructuring

Second, the financing must aim to minimise the risk the company remains passive and continues wasting resources. A cautionary tale is found in the DIP financing of Eastern Airlines, which kept flying in bankruptcy until the value of its assets had been driven almost to zero. To avoid this problem, we propose that while the government provides the funding for the loans and the guarantee for most of the losses, the actual lending decision should be made by a commercial bank. In exchange for the underwriting fees, the private bank could be held liable for some percentage of the last losses on the value of GM’s debt. In this way, we impose a limit on GM’s ability to waste resources. When the value of its assets has been impaired, GM will be unable to get any new financing, because the private institutions will pull the plug. In this way we avoid the risk that GM will die of premature death in Chapter 11, but we also prevent GM from exploiting the government guarantee to delay the restructuring.

Third, the GM bankruptcy must avoid setting off a costly chain reaction of other bankruptcies. In particular, the bankruptcy of related suppliers must be avoided. If GM were to default on its payments to these suppliers, many of them would be broke, with negative consequences for the other manufacturers of cars in the United States. DIP financing must therefore be sufficient to allow GM to make its payments to suppliers. Furthermore, bankruptcies of foreign subsidiaries should also be avoided. As the Lehman bankruptcy has shown, foreign proceedings are more rigid and would contribute to the possibility of excessive liquidation.

Fourth, GM must emerge from Chapter 11 as a smaller company. This necessitates shutting down the most money-losing segments of the company, while also providing incentives to foreign manufacturers to buy some of GM’s assets without union contracts attached.

Fifth, GM must emerge from Chapter 11 without massive pension obligations. Legally, the US government is on the hook for any underfunding of accrued pension benefits for US workers, with a cap of $51,750 per person year. Much of the unloading of GM’s pension will therefore happen mechanically and unfortunately will come at a substantial cost to taxpayers. As showed by the United Airlines bankruptcy, it is impossible to know exactly what the magnitude of the government liability will be before the bankruptcy itself happens, due to uncertainty about the value of the assets and also the fact that the government turns the pension liability into a hard riskless claim. Our best estimate is that the underfunded US pensions themselves could cost taxpayers $23 billion. The alternative, however, is worse: to waste money propping up GM and hope that the government pension liability shrinks going forward through a miraculous performance of GM’s pension fund (and risking it might get even larger).

Sixth, GM must emerge from Chapter 11 without enormous retiree medical care liabilities. By negotiating with its white-collar employees, GM has been able to get the unfunded part of this liability down to a “mere” $34 billion. Furthermore, GM and the United Auto Workers (UAW) have agreed to a special fund for a Voluntary Employee Beneficiaries Association (VEBA). Under this agreement, however, billions of dollars of additional cash contributions are due from GM in the next several years. The agreement will have to be revisited in Chapter 11. We recommend that some of the liability be funded with shares in the reorganised company. This is how United Airlines pilots were compensated for some of their losses from uncovered pension benefits in the UAL bankruptcy.

Assuring Consumers: Insuring Warranties

Finally, the bankruptcy plan would have to address perhaps the biggest challenge of a Chapter 11 filing: the risk that the customers will desert GM because of concerns about the value of its car warranties. People were not afraid to fly United Airlines when it was in Chapter 11. However, a trip is a relatively short-lived transaction and a customer does not care about the fate of the airline once he has arrived home. With cars, the fear of losing the warranty might be large enough that the potential customers will shy away. Even worse, this fear might become self-fulfilling: if enough customers avoid GM, the survival of the company is at risk.

To avoid this problem, we propose that GM be required to purchase insurance for its warrantees, and to do so in such a way that its incentives to improve quality are not diminished. There are already well-established third party providers of car warranties. To avoid the moral hazard, both the workers and the managers could be asked pay for the deterioration of car quality. For example, both required contributions to the VEBA and executive bonuses could be indexed to the cost of servicing the warranty.

How Much Will It Cost?

The restructuring cost at GM will of course be high, both in human and financial terms. But the alternative is worse: to spend $25 billion on aggravating and postponing the problem. It would be better to give away that money directly to the workers rather than let GM decide how to dissipate it. At over $200,000 for each of GM’s 123,000 North American employees it would a very nice gift. The taxpayers’ cost would be the same, but at least the money would help secure a future to hard-hit households.

Overall, however, we believe that paying off workers and liquidating the company is equivalent to putting the patient out of his misery before attempting to administer the best economic medicine. Some may argue that GM has been receiving medicine from taxpayers for quite some time, but clearly it has been receiving the wrong medicine. A Chapter 11 bankruptcy gives a firm that needs to restructure the chance to recover. If Chapter 11 cannot save GM, then nothing can.

Joshua Rauh is Associate Professor of Finance and the Charles M. Harper Faculty Fellow at the University of Chicago Booth School of Business. Luigi Zingales is the Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago and a CEPR Research Fellow.

Sheila Bair: Well basically, it’s a proposal to try to provide some financial incentives, some responsible financial incentives, to get these loans modified. There are a lot of loans that are unnecessarily going into foreclosure that could be restructured, and present greater value if they were restructured in keeping the homeowners in the home. So it’s based on the loan modification protocol we developed with IndyMac.

Pretty much, borrowers would get, borrowers with unaffordable mortgages can get a reduction in payment to 31 percent of their principal and mortgage payment related – principal/interest/taxes and insurance -- as a percentage of their pretax income down to 31 percent. Get there through an interest rate reduction, extended amortization, and in some cases, principal forbearance. And then, if the servicer and the investors would agree to modify the loan along those lines, there would be some loss sharing in the event that that loan would re-default later on.

Kudlow: Let me just ask you, because we’ve heard several of these kinds of proposals -- the Treasury, Fannie, Freddie and so forth -- are you going to be reducing the principal amount on the home loan?

Bair: No. The IndyMac protocol does not do that. Most of the pooling and servicing agreements, they provide wide flexibility to modify loans, but most do prohibit principal write-downs, or make it very difficult. So this protocol is based on making an affordable payment, not reducing principal, but getting to an affordable payment, again, through interest rate reductions, extended amortization, and in some cases, principal forbearance, meaning that some amount of the principal might be permanently deferred. But if the loan was refinanced, or the house was sold, it would have to be paid back at that time.

Kudlow: Okay, if a loan is underwater…

Bair: It’s not focused on whether you’re underwater or not. What we strongly believe is key is that most people are willing to ride this out. They view their home as a place to live, not as a leveraged investment. And if they have an affordable payment, they will want to stay in their homes and they will be motivated to stay in their homes and make their mortgage payment. So we’re focused on affordability.

Kudlow: But you are going to give them an interest rate break?

Bair: Yes, there would be an interest rate break.

Kudlow: And how would you determine that interest rate break?

Bair: Well at IndyMac, we pretty much start with giving everyone a 30-year fixed rate mortgage at the Freddie Mac survey rate, the prime rate, which is a little above 6 percent now. Some mortgages have to be reduced further than that to get to an affordable payment. For those, we’ll take the interest rate all the way down to 3 percent for a period of 5 years. And after 5 years, it will gradually increase by 1 percent until it gets back to the Freddie Mac rate. So if you were at 3 percent, getting back to 6 percent, it would be a total of 8 years. So it’s a very gradual reset after 5 years. Also, if that doesn’t get you to 31 percent (debt to income) we’ll extend the amortization to 40 years. And, as I said, in about 10 percent of cases, we also have to forbear a certain amount of principal. But most of the loans we find at IndyMac we can get there through an interest rate reduction.

Kudlow: Now let me ask you this. As I understand it, you’re going to put a federal guarantee behind this. So if there is a default, or a foreclosure, the lender is going to get at least half their money back?

Bair: That’s right. Except for loans with a loan to value ratio of 100 percent or less, it would be a 50 percent loss shared. That would gradually phase out for loans that had very high LTVs of 150 percent or greater. It would exclude early payment defaults though, I think that’s important to emphasize. The loan would have to perform for 6 months, before the government loss share would kick in. The statistics we’ve looked at show that the re-defaults go down pretty significantly once the borrower has been able to demonstrate that they can make the payment at 6 months. So that’s an important condition.

Kudlow: All right. Let me ask you this though. A lot of people have raised a problem with these loan modifications and so forth about re-default. That people get in these deals, but they wind up, 50 percent of them or thereabouts, wind up defaulting anyhow. Since you’re putting federal guarantees behind this it could cost taxpayers a fortune, but at the end of the day, we’re not really going to do a lot on the foreclosure issue. How do you respond to that criticism?

Bair: Well, I have a number of responses to that. First of all, I think some of the re-default rates that you’ve seen, what you’re talking about, you’re including the early payment defaults with that 50 percent figure. We would exclude the early payment defaults. We would also require a meaningful, real, permanent loan modification.

Some of the reason you’re having these high re-default rates is because loans are not being meaningfully modified. The principal and interest may be deferred for a couple of months, and then it’s stuck back into the payments, so that after a couple months the payment is even higher. That’s not a permanent sustainable loan modification. So, to the extent that some servicers have just been kicking the can down the road with even steeper payment hikes after a few months, that doesn’t really solve the problem. We think that has also fed into the high re-default rates.

Kudlow: So you’re sort of downplaying the re-default rate.

Bair: No I’m not. No…

Kudlow: It’s a tricky business. A lot of economists have looked at this…

Bair: It’s a very tricky business…

Kudlow: You know, I want to just juxtapose that, I want to play devil’s advocate.

Bair: Okay, please.

Kudlow: I don’t know who’s right and who’s wrong. You know more about this than I do.

Bair: Yup. We go through this a lot. Please, ask the question.

Kudlow: I just want to ask you, look, you’ve already seen in the difficult states out West primarily, the foreclosure rates have gone sky high, but the foreclosure prices at resale or auction have plunged and sales are rising. I mean you look at California and Nevada, Arizona, the places that have been hit the hardest, they’re the ones showing the sales coming back the fastest. Now to me, the marketplace is probably best at sorting this out and we’re probably, I don’t know 2/3rds of the way home. So are you gonna put taxpayers on the hook at a late stage in the game? Would it might be better to just let the market finish the job?

Bair: Well, if you’re right, and if the market is starting to bottom out -- and I’m not sure that’s the case because I think these escalating foreclosures are creating more artificial downward pressure on home prices -- the costs should be minimized if the collateral values are in fact bottoming out. If that is the case, that should reduce the cost of the program. We have looked at re-default rates very carefully. And we are assuming a 33 percent, 1/3rd re-default rate with our program in estimating the cost of this program at less than $25 billion dollars. And again, we think that’s a very conservative and prudent re-default assumption.

But again, this is a meaningful loan modification with a meaningful payment reduction. We’ve looked at statistics from a number of servicers, and the re-default rates, again, go down significantly if you get past that early payment default period. And, if you provide for meaningful payment reduction, a lot of the so-called modifications that have been occurring aren’t really modifications. They’ve just been kicking the can down the road for a couple of months. So we have looked at this very carefully.

[Break]

Kudlow: As I understand it, the Treasury does not want you to take any of their TARP money to provide this loan guarantee.

Bair: That’s right.

Kudlow: They’re sort of harboring this TARP money.

Bair: Right.

Kudlow: I myself would like to put a tarp over the entire TARP. But I guess that’s a whole different segment. But let me go there. Where do you stand on this proposal, if the Treasury is against you, I mean, do you need a congressional authorization on this to start it up? How’s this gonna work?

Bair: Well we continue to talk with Treasury. Secretary Paulson has expressed receptivity to this plan and support for the general concept, but he doesn’t think this is the way to use the TARP funds. So in that area, we do disagree. I think you know, the original purpose of TARP was to buy mortgage related assets, distressed mortgage related assets, and foreclosure prevention and the promotion of loss mitigation and loan modification is expressly referenced in the statutory language. And I think we heard at the hearing today that Congress thought part of this money would at least be used for foreclosure prevention. So we think it’s very, very consistent with what Congress had in mind when they originally appropriated the funds.

Kudlow: So you’re saying in effect, when the new administration comes in, you might see the light of day on this plan.

Bair: Well, we might. I haven’t given up on the current administration yet. We continue to talk to Secretary Paulson and Chairman Bernanke. I think we would really like to see something put into place now. We’ve waited for a long time. We’ve waited too long. We’re behind the curve on foreclosures, and I don’t think that the housing prices are going to find their much needed bottom if we keep having unnecessary foreclosures occur because of the convoluted economic incentives that are currently provided in these private label securitization trusts.

Kudlow: And also, speaking of the new administration, now of course, you are the most powerful woman in America…

Bair: Oh right…

Kudlow: There’s no question about that. Have you had any feelers to become the Treasury Secretary under President-elect Obama? There are a lot of rumors Ms. Bair.

Bair: [Laughing] Well yes, if I had, I wouldn’t tell you. I wouldn’t comment on that at all. I’m very happy with the job that I’ve got. I think we’re doing a great job. I’m very proud of the FDIC staff. They are working 24/7. I hope the public appreciates what a great job and hard work that all the FDIC staff are doing. And we’re a good team there, and I’m happy there, to be at that helm. I do think the new administration should have wide latitude to pick who they want on their economic team. So I will accommodate whatever the new president’s wishes are. But I’m very happy where I am.

Kudlow: But there’s no question, your term goes to when? 2011?

Bair: 2011.

Kudlow: And I don’t hear you, you’re not saying you wouldn’t take the Treasury post if it were offered.

Bair: Well, I think that’s a very prestigious job. I think anybody would have to think twice about turning down a job like that. But I’m very happy with the job I have now. I’m quite content and very, very proud of our team at the FDIC. And you know I think we need to just keep focusing on the job we have to do right now.

Kudlow: All right, Ms. Sheila Bair. As always, we appreciate your coming on the show.

Bair: Nice being here. Thank you.

None of this should surprise us. By definition, federal money invested in private companies can only weaken them. Money supplied absent the sometimes rough hand of market discipline allows its unlucky recipients to delay the changes that brought them to the brink of collapse to begin with, all the while allowing the architects of those same mistakes to remain in place. It can’t be stressed enough that companies don’t so much fail due to lack of money as they collapse because investors lose faith in the executives in charge.

But even more problematic is that despite Paulson’s protests otherwise, there is no such thing as a government handout that doesn’t come with strings attached. Many, including Paulson, will note that the federal government’s shares are non-voting, but whether that’s true or not misses the point. Indeed, just six weeks in we’re already seeing the harm wrought by our federal minders.

First off, rule or no rule, the certain result of the federal lifeline offered to banks will be a curtailment of pay. That is so because a frightened political class eager to appease an angry electorate will make sure to demagogue any large pay packages that appear too big. The top executives at Goldman Sachs have already made public their plan to forego bonuses this year, and while this would have been a tough bonus year regardless of the political climate, it’s a near certainty that top performers elsewhere will be told that their pay must reflect market realities along with political realities.

To many the above might seem just, but a major part of Wall Street and banking’s appeal generally is the pay. To the extent that the young and ambitious shun the industry due to curbs on compensation, the average American will be burned twice. First because a weakened financial sector means that tomorrow’s Googles and Intels will have less skillful sources of finance to access for their world-changing innovations. Second, to the extent that all Americans pay taxes in this country, it will hardly help that the funds invested with their dollars will be overseen by the less qualified individuals willing to work in an industry that has lost some of its allure.

So to the extent that federal funds allegedly saved certain banks in the near-term, those same banks will surely pay over the long-term as the best and brightest exit the industry. There are no numbers supporting this yet, but it would be folly to assume that Goldman Sachs will recruit as effectively (Microsoft’s Bill Gates long noted that GS served as his greatest competitor when it came to attracting fecund minds) going forward considering that handsome compensation was one of the firm’s greatest calling cards. Goldman’s stock price surely to some degree reflects a future that is less bright.

But perhaps what will weaken Goldman the most over time was the requirement that it reclassify itself as a banking entity in order to partake in the Treasury’s giveaway program. It’s long been said that Goldman Sachs is a hedge fund wrapped inside an investment bank, and while it would be overkill to assume that its aggressive culture will be completely emasculated, it’s also true that as a heavily regulated bank, it will no longer be able to take the risks associated with big returns and impressive pay.

And when we consider bank lending generally, there was seemingly a broad consensus about how we got here. In particular, there existed the belief that the non-economic lending spawned by the Community Reinvestment Act and the empowerment of Fannie and Freddie was the major driver of a financial crisis that led banks to line up for federal help to begin with.

The above is interesting considering how many now countenance Paulson’s investments in the banking system. Speaking once again to the truth that there’s no federal money absent strings attached, Treasury has made it clear that banks must aggressively lend in order to lift the economy out of the ditch. That being the case, it’s very apparent that to the degree banks comply, more non-economic lending will materialize such that the seeds of the next financial crisis are being planted right now.

Worse, governmental demands that banks lend with no regard to prevailing market conditions are an impoverishing concept. How soon we forgot that a successful capitalist system is reliant on the efficient deployment of capital.

So what about the Frost Banks of the world that were careful, and in avoiding big mistakes, had no need to access federal funds? Is it fair that the prudent will have to compete with the imprudent now playing with funny money? Isn't capitalism a system of success and failure whereby the survivors gobble up those who don't succeed? If so, a bailout that so many said was essential to the health of our capitalist system will tear down capitalism's basic foundations in the process.

With bank shares continuing to fall, the best long-term scenario we can hope for is that thanks to the federal government’s shocking ineptitude as economic backstop, we’ll have historical precedent to bolster the non-intervention argument the next time time around; "next time" perhaps coming sooner than we think given a Treasury that has pushed money out to banks while shouting, "Lend!"

So while it’s surely nice to think that government money borrowed from the private sector can somehow smooth out periods of economic uncertainty, TARP’s impressive failure shows yet again that far from stimulating, government “help” is an oxymoron that bats 1.000 when it comes to scaring away investors.

Decisions about business investment are even starker. Businesses are reluctant to invest at a time when consumer demand is plummeting and they face unprecedented risk penalties on their borrowing costs. They are also facing huge uncertainties. What kinds of power plants will be acceptable in the future? Will they be allowed to emit carbon dioxide as in the past? Can the US still afford a suburban lifestyle, with sprawling homes in far-flung communities that require long-distance automobile commutes?

To a large extent, economic recovery will depend on a much clearer sense of the direction of future economic change. That is largely the job of government. After the confused and misguided leadership of the administration of US President George W. Bush, which failed to give any clear path to energy, health, climate and financial policies, president-elect Barack Obama will have to start charting a course that defines the US economy’s future direction.

The US is not the only economy in this equation. We need a global vision of sustainable recovery that includes leadership from China, India, Europe, Latin America and, yes, even Africa, long marginalized from the world economy, but very much part of it now.

There are a few clear points amidst the large uncertainties and confusions. First, the US cannot continue borrowing from the rest of the world as it has for the past eight years. The US’ net exports will have to increase, meaning that the net exports of China, Japan and other surplus countries will consequently decrease. The adjustments needed amount to a sizeable deficit-to-balance swing of about US$700 billion in the US current account, or nearly 5 percent of US GNP.

China’s trade surplus might shrink by half of that amount (with cuts in trade surpluses also spread over other global regions), meaning a shift in Chinese GNP toward internal demand and away from net exports equal to between 5 percent and 10 percent of its GNP. Fortunately, China is promoting a major domestic expansion.

Second, the decline in US consumption should also be partly offset by a rise in US investment. However, private business will not step up investment unless there is a clear policy direction for the economy. Obama has emphasized the need for a “green recovery,” that is, one based on sustainable technologies, not merely on consumption spending.

The US auto industry should be retooled for low carbon emission automobiles, either plug-in hybrids or pure battery-operated vehicles. Either technology will depend on a national electricity grid that uses low emission forms of power generation, such as wind, solar, nuclear, or coal-fired plants that capture and store the carbon dioxide emissions. All of these technologies will require public funding alongside private investment.

Third, the US recovery will not be credible unless there is also a strategy for getting the government’s own finances back in order. Bush’s idea of economic policy was to cut taxes three times while boosting spending on war. The result is a massive budget deficit, which will expand to gargantuan proportions in the coming year (perhaps US$1 trillion) under the added weight of recession, bank bailouts and short-term fiscal stimulus measures.

Obama will need to put forward a medium-term fiscal plan that restores government finances. This will include ending the war in Iraq, raising taxes on the rich and also gradually phasing in new consumption taxes. The US currently collects the lowest ratio of taxes to national income among rich nations. This will have to change.

Fourth, the world’s poor regions need to be seen as investment opportunities, not as threats or places to ignore. At a time when the major infrastructure companies of the US, Europe and Japan will have serious excess capacity, the World Bank, the European Investment Bank, the US Export-Import Bank, the African Development Bank and other public investment funds should be financing large-scale infrastructure spending in Africa to build roads, power plants, ports and telecommunications systems.

So long as the credits are long term and carry a modest interest rate (say, 25-year loans at 5 percent per annum), the recipient countries could repay the loans out of the significant boost in incomes that would result over the course of a generation. The benefits would be extraordinary for both Africa and the rich countries, which would be putting their businesses and skilled workers back to work. Such loans, of course, would require a major global initiative at a time when even blue-chip companies cannot borrow overnight, much less for 25 years.

In typical business cycles, countries are usually left to manage the recovery largely on their own. This time we will need global cooperation. Recovery will require major shifts in trade imbalances, technologies and public budgets.

These large-scale changes will have to be coordinated, at least informally if not tightly, among the major economies. Each should understand the basic directions of change that will be required at the national level and globally, and all nations must share in the deployment of new sustainable technologies and in the co-financing of global responsibilities, such as increased investments in African infrastructure.

We have arrived at a moment in history when cooperative global political leadership is more important than ever. Fortunately, the US has taken a huge step forward with Obama’s election. Now to action.

Jeffrey Sachs is a professor of economics and director of the Earth Institute at Columbia University..

And it's just common sense the economy can't thrive without modern, high-capacity roads, rail lines, seaports, electric power, aqueducts, reservoirs, natural-gas lines, the Internet and all the other things that help the private sector produce goods and services.

But the big question right now is how to get a stricken economy moving again, and infrastructure spending is not the answer.

Critics have already noted an obvious problem of timing. Even a crash public-works program will take a while to reach the point where people are put to work on construction sites or in factories.

And don't forget the greens. Obama certainly can't. The environmental movement has never let the health of the economy get in its way, and there's no reason to believe it has changed its ways.

This isn't the 1930s, when the federal government altered much of the American landscape with massive reclamation projects. A New Deal today would have no dams — and, if the enviros get their way, it would lack new highways and anything to do with nuclear power.

Figure politics to get in the mix when the government spends money, even if it claims to have only economics in mind.

In the marketplace, money naturally gravitates toward real needs, signaled by the willingness of people to pay for goods and services out of their own pockets.

In government spending, money follows power. It is channeled by key officeholders to favored constituencies. So when a national government tries to breathe life into an economy with massive spending, the result is massive economic inefficiency.

It's an undying Democratic Party myth that Franklin Roosevelt's New Deal spending helped end the Great Depression (or at least relieved suffering). The hard fact is that unemployment stayed well into the double digits until the early stages of World War II.

There seems less argument over a more recent case of failed big-government stimulus, that of Japan in the 1990s. The incoming administration should study that lost decade well, because it started with disturbing parallels to our own time and place.

Japan got into trouble with the collapse of a real-estate bubble and a subsequent breakdown of its banking system.

The Japanese government made one mistake that U.S. policymakers are at least trying to avoid now: It did not move aggressively to clean up the bad debt on banks' balance sheets.

Then it made another error that the pending Obama administration seems tempted to repeat. It tried to revive the economy by increasing the government's share of it.

The result was plenty of pork and almost no growth. Japanese government spending (at all levels) grew from 31% during the '90s to 38% of GDP more recently.

Meanwhile, average Japanese annual economic growth fell from 4.1% in the '80s to just 1% in the '90s. From '92 to '99, industrial output grew only 0.7% compared with nearly 40% in the U.S., which spent the decade reducing government spending as a share of GDP (this was the era of a GOP Congress that took its job seriously).

There's a cautionary tale here for Barack Obama, but also a reminder that he has a choice. The current crisis is serious enough to excuse, even demand, changes in positions he had staked out during much different conditions on the campaign trail.

He also can find precedent for sound policy in his own party's history. FDR is not his only model in the Democrat pantheon. He should take his cue in this case from a liberal with whom he is often compared, John Kennedy, who chose tax cuts as a way to spur growth by freeing up private capital.

Members of Obama's party, along with his own ideas on tax "fairness," will be pushing him toward the slow lane of big spending. As JFK knew, there's a better way.

This last occurred in 1979 and 1980, when inflation reached 13 percent and government seemed incapable of suppressing it. No one knew what might happen. By 1980, interest rates on 30-year mortgages neared 13 percent. Would inflation go to 15 or 20 percent? (The brutal 1981-82 recession ended the high inflation.) There is a comparable foreboding today. Perhaps Barack Obama will change that, but so far, government officials, business leaders and economists seem overwhelmed. They're constantly playing catch-up and losing. Americans feel unprotected against accumulating misfortune.

The hyper-anxiety is not irrational pessimism, though it may prove unfounded. Every major episode of this crisis -- from Bear Stearns's failure to General Motors' possible bankruptcy -- has come as a surprise. Similarly, the crisis's three main causes have repeatedly been underestimated: the burst housing "bubble"; fragile financial institutions; and a reversal of the "wealth effect." Of these, the last is least recognized.

The "wealth effect" refers to the tendency of people to adjust their spending as their wealth -- concentrated heavily in housing and stocks -- changes. When wealth rises, spending strengthens; when wealth falls, spending weakens. For the past quarter-century, higher stock prices and home values propelled the economy forward by inducing Americans to spend more of their incomes and to borrow more. In 1982, the personal saving rate was 11 percent of disposable income; by 2006, it was almost zero. The lowered saving rate added about $1 trillion annually to consumer spending -- more shoes, laptops, books -- out of a total of about $10 trillion.

But now the wealth effect is reversing. As stock and home values drop, Americans are scrambling to increase savings and curb spending. The plausible math is daunting. Since September 2007, Americans' personal wealth has dropped about $9 trillion, says economist Nigel Gault of IHS Global Insight. A common estimate is that every dollar's change in wealth causes people to change their spending by 5 cents. If so, the hit to consumer spending would be $450 billion ($9 trillion times .05). Gault thinks the effect would occur over several years.

Even this might be too optimistic. Everywhere, financial commentators urge "belt tightening" and more thrift. If the swing toward saving is too sharp, consumer spending wouldn't just weaken; it would collapse. Vehicle sales have already plunged. In 2005, they totaled almost 17 million; Global Insight's 2009 projection is 12.2 million. And these problems feed on each other. Lower consumer spending depresses profits and stock prices, which corrodes confidence, further dampens spending, raises unemployment and increases loan defaults. Credit card losses could be the next big blow to financial institutions.

The case for a sizable economic "stimulus" package is that it would temporarily compensate for the erosion of consumer spending. But if the positive "wealth effect" is now giving way to a lasting negative or neutral "wealth effect" -- as people try to replenish savings and offset lost wealth -- then even a recovery would be sluggish. A new source of demand is needed to sustain faster growth. An obvious solution is for high-saving Asian countries, led by China, to consume and spend more so that their imports increase. Whether they have the political capacity to reduce their dependence on export-led growth is unclear.

The scary words "depression" and "deflation" are bandied about because an economic free fall seems possible, even if it is unlikely. With time, economic slumps correct themselves as borrowers repay debts, surplus inventories are sold, industries consolidate and government policies promote recovery. They may now. But the mechanics of this cycle are sufficiently different from any since World War II as to raise doubts. Americans are less upset by hardships they've experienced than by those they imagine.

So instead of pricing in the present, stock markets are most useful for offering a snapshot of what things will look like in the future. Treasury Secretary Hank Paulson surely isn’t helping the Obama market with his disastrous imposition of TARP, but then it should also be said that Barack Obama is not helping himself.

It was surely gracious of our president-elect to acknowledge that there’s only one president at a time, but the problem there is that his relative quietude until recently has allowed the media to somewhat define what an Obama economic program will look like. Judging by the overall decline in share prices since, investors aren’t impressed.

Investor fear is well-founded. With Obama tucked away in Chicago, here’s how a Wall Street Journal article from last week described the Obama economic program:

“From autos to energy to banking, President-elect Barack Obama is promising to intervene in the economy in ways that Washington hasn’t tried since the 1970s, favoring some industries and products while hobbling others.”

“Under his financial policies, banks seeking government assistance would be forced to lend and halt foreclosures. Automobile companies would be pushed to change their product lines to more advanced, fuel-efficient vehicles. Billions of federal dollars would promote solar, wind and biomass energy, while dirty coal power could be priced out of business.”

Looked at from an historical perspective, notwithstanding market strength over the last two sessions, it’s no surprise that stocks are buckling at present. In promising to intervene in the economy in ways not seen since the ‘70s, Obama is implicitly promising to take us back to a decade in which stocks were flat in nominal terms, and well down in real terms due to dollar debasement.

Japan most famously engaged in the industrial favoritism, federal bailouts, and massive infrastructure spending meant to expand its economy beginning in the late ‘80s, and that Obama seemingly supports today. The result after twenty mostly recessionary years is a Nikkei average that is 79% below its all-time highs.

And while there’s some consensus that non-economic lending brought us to this unfortunate economic period, Obama promises more of the same given his desire to continue the politicization of the bank lending that has proven so unsuccessful under President Bush.

Perhaps not surprisingly, Obama didn’t run from the generalized assumptions about how he would conduct economic policy over the weekend. Indeed, he seemed to embrace the industrial policies and stimulus spending that has only served to weaken the economy, and which has rewarded the Bush administration with some of the lowest approval ratings on record. Obama would do well to change his tune.

That is so because “stimulus” is non-stimulative. Governments can only spend to the extent that the private economy provides tax revenues. When governments spend money taken from the private sector, that spending is merely a tax on real growth for capital being redistributed by the inefficient hand of the federal government as opposed to invested by private economic actors.

The above in mind, many on the left and right persist with the myth that if governments spend enough, economies grow. That World War II led to the end of the Great Depression is used as evidence supporting this faulty idea. Readers should not be fooled.

The spending wrought by the 2nd World War in no way saved the economy. Instead, it should be noted that the Laffer Curve is a dynamic one. With the U.S. at war, the willingness of Americans to work and produce rose. In short, the high tax rates imposed during the Hoover and Roosevelt years were no longer a work disincentive given a generalized desire among Americans to provide the federal government with revenues to fight the war. As always, economic growth is a function of productive work effort, and the war years drove Americans to work much harder irrespective of the tax rate.

Returning to the present, markets continue to price in the certain unfortunate results of Paulson’s disastrous TARP plan, and worse, they’re forced to account for more of the same from a president-elect who promised change. Far from change, the Obama economic plan so far seems to insure that we’ll get more of the same economy-enervating policies that historians will surely point to when they describe why a small market correction turned into a rout.

So with the markets clamoring for reassurance, it’s essential that Obama talk about the economy, and in doing so cheer his base of support without offending investors. Some would say that’s an oxymoronic task, but it’s really not.

About the dollar, he should promise a reversal of the weak-dollar policies of the Bush administration that eviscerated the paychecks of the average American, all the while setting the stage for the mal-investment in property that drove capital away from the wage economy. The dollar’s health and stability is arguably the greatest driver of presidential success, so Obama must not wait to clarify his desire for change in this area.

When it comes to trade, Obama must make clear that tariffs hurt the poorest among us the most for making life’s essentials more expensive. Owing to a desire on his part to increase the real value of the average paycheck, Obama should make clear that he will not tax the free exchange of goods that regularly enhances the lifestyles of poor and rich alike.

About regulation, Obama should note that it’s always the regulated companies that fail such that taxpayers are left to clean up the mess. Rather than allowing big corporations to hide behind regulations, he should make plain that in the future big firms will have to fend for themselves; their failure their own.

As for taxes, some of Obama’s most energetic support comes from young adults who’ve recently entered the work force. With their future in mind, Obama should take tax increases off the table given his desire not to penalize the future success of a significant portion of his base.

If Obama clarifies his stances with growth policies wrapped in populist rhetoric, markets and the economy will rally. And while spending on government programs is surely a tax too, it’s safe to say a growing economy will make some of the more offensive social-welfare legislation that he seeks to pass less of an issue.

So with stock markets uncertain since November 5th, it’s necessary for Obama to talk more in order to remove some of the fear and uncertainty in the markets about what his policies might look like. Lacking clarity, investors can only guess about what’s ahead based on Obama’s decidedly anti-business rhetoric used during the campaign. Whatever direction he takes, it should be clear that today’s stock market is the Obama stock market, so it’s up to him to decide its basic direction.

As a matter of politics, the choice seems a no-brainer: help Detroit. The short-run costs of lost jobs and production are, politically, too painful to incur. The only debate is over the cost and scope of a bailout. Fortunately, politics is not the only arena in which these types of decisions get made. In considering the long-run economics involved and how our actions today will shape the future of American capitalism, what are the lessons of insurgency?

* * * *
One of the most overused phrases today is “inflection point”—we’re said to be at a political, an economic, a grand global inflection point. Notwithstanding that true inflection points simply cannot occur at the same frequency at which they are declared, the Detroit dilemma does seem to present a fundamental question about the shape of our economy.

Set aside the conventional categories of regulation v. deregulation, or fettered v. unfettered free markets. Let’s ask a basic question: how does our economy progress? We must first define what we mean by “progress.” Certainly, new types of goods and services are part of this, but that cannot be all—above a certain level of income and material prosperity, a person’s (reported) happiness doesn’t increase that much. Part of this is our relative frame of reference: we compare our current situation to that of our contemporaries, not to our parents and grandparents. Few Americans today would likely be willing to give up their current standard of living for one that prevailed in 1950 or 1900.

So what else counts as economic progress? Most people would probably include some description of their individual capacity—the extent to which the economy permits them to explore and enrich their talents and dreams. That sounds hokey, and is wholly unquantifiable, but I would bet that it resonates with everyone. People prize their uniqueness, and the economic system that gives widest scope to that value will also enjoy the greatest progress.

This is what capitalism does. In particular, it permits individuals to challenge the established order of things—capitalism is about insurgency. The word “insurgency” conveys, in a military context, disorder and mess; the United States military ran into trouble in Iraq because our conventionally-designed forces were not prepared for the disorganized structure of the opposition.

In the economic sphere, too, insurgency means disorder and mess, yet these are the true sources of prosperity and progress. Take some examples. In the early twentieth century, the city of Los Angeles was a sleepy settlement at the commercial margins of the country; in particular, New York reigned supreme in entertainment and the new area of film. But as we all know, today Los Angeles is synonymous with film production. Part of this was climate: it was easier and cheaper to make films year-round in southern California.

The decisive factor, however, was that the established entertainment organizations in New York—typified by “the Trust,” the Motion Picture Patents Company—sought to control and constrain the emerging film industry. As a result of these strictures, a number of individuals and their new studios (including William Fox and Carl Laemmle, creator of Universal Studios) decamped for Los Angeles. They could only succeed through an insurgency against the existing entertainment order.

Likewise, the technological basis of the Information Revolution—the transistor—was developed by the behemoth Bell Labs. Its revolutionary promise, however, only came through the work of insurgents, namely, Fairchild Semiconductor (which broke away from Shockley Labs) and the long line of companies it helped spawn in Silicon Valley (including Intel and Advanced Micro Devices.

This is the hallmark of capitalism: it opens the door to challenge, and it is frequently the outsiders, the insurgents, gambling on a new and unproven technology or way of business, who succeed. These insurgents, of course, then become the next generation of established authorities—Intel today faces constant challenges to its dominance. This messy pattern of rise and fall, giving full scope to the expression of individual authenticity, is the wellspring of progress.

Nearly a century ago, the famous Belgian historian Henri Pirenne described the capitalist system in just these terms: “At every change in economic organization we find a breach of continuity. It is as if the capitalists who have up to that time been active, recognize that they are incapable of adapting themselves to conditions which are evoked by needs hitherto unknown and which call for methods hitherto unemployed. … In their place arise new men, courageous and enterprising, who boldly permit themselves to be driven by the wind actually blowing and who know how to trim their sails to take advantage of it.”

For this to work, however, the people and organizations in the established order must give way; they must be willing to give a wide berth to challenges to their authority. And it is here that economic and regulatory policy can play a vital role.

Too often, we think of regulation as a hindrance to business, as something fundamentally anti-market. Yet anti-business and anti-market are very different. Companies often seek regulation as a way to protect their business from competition. Who, after all, likes challenges to their products and services that they worked hard to secure? And what better way to protect them than through regulation? Innovation takes effort; regulatory protection is easier.

The challenge is to orient regulation such that it protects access to entry—our economic policy must, in other words, become pro-insurgent. It must seek to maintain competition and help structure the economic playing field so as to give the widest scope to individuals and companies working at the margins to challenge existing ways of doing things. The icon of this approach is the inventor in the garage, but it could just as easily be the middle manager who sees an opportunity to improve some line of business, or the retiree who decides to apply her skill and experience to an off-the-wall idea.

* * * *
Ruminating on different types of soft despotism in Democracy in America, Alexis de Tocqueville saw that people would, quite naturally, seek economic security from the state. In some ways, this might appear benign: government “foresees and supplies their necessities, facilitates their pleasures, manages their principal concerns, directs their industry,” etc. This doesn’t necessarily “break men’s will, but softens, bends, and guides it.” The greatest drawback, Tocqueville saw, would be in the unseen and unimagined possibilities that would not be realized—protection and security would “not destroy anything, but prevent[] much being born.” The cost lies in preventing the realization of the new.

So we might end up bailing out Detroit in one form or another. That would be counter-insurgency, defending the established, and it characterizes Europe, a region not recently known for dynamic growth. But as a tradeoff, we must again reorient our economic policy and regulation toward the messiness of economic insurgency that is the true key to lasting prosperity.

The same charge was made by Democrats well into 2001. "I think what we're seeing is a talking down of the economy," then House Minority Leader Dick Gephardt said that March. "I think that kind of economic leadership is irresponsible."

Big media also chimed in. "It is important for President Bush to quit talking down the economy in order to build congressional and public support for his tax cut," said the New York Times. "A high-risk bid to win support for his tax cuts" is how Time put it.

Gene Sperling, a key economic adviser to President Clinton, said "it is very possible that the president's continued drumbeat on talking down the economy has become a self-fulfilling prophecy."

Pretty damning, if true. Except that Bush and Vice President-elect Cheney were right: The economy was on the front edge of a recession in December 2000 — it started in March 2001 and ended that November — and his tax plan almost certainly helped make it one of the mildest downturns on record.

Fast forward to this week. In announcing his Treasury pick, Obama painted an exceedingly grim picture — that of an economy "trapped in a vicious cycle," "likely to get worse before it gets better" and in danger of losing "millions of jobs" next year.

Not a peep, however, has been heard about Obama "talking down the economy" to serve his political interests.

The new president stands a better chance of enacting his agenda if the public believes the economy is on the edge of the abyss. And if things don't turn out as bad as he's saying, Obama can later claim credit for preventing a catastrophe.

But then, why should the media start complaining now? They've let Democrats get away with their trash talk for years.

Back in 1992, to cite just one example, Bill Clinton charged that George H.W. Bush's presidency "has produced slower economic growth, slower job growth and slower income growth than any administration since the Great Depression." No one complained then, and Clinton's dour depiction, aided and abetted by the media, helped get him into the White House.

Obama and other Democratic doomsayers may well be right this time. But nobody knows for sure how the economy will turn out.

Meantime, they would be wise to remember what Time said in early 2001 by way of advice to a new president: "The worry factor is not to be underplayed. Recessions and bear markets are as much about psychology as fundamentals."

Having the president, congressional leaders and the media continually talking about depressions, catastrophes, historic crises and vicious cycles is a good way of making sure it all comes true.

The economic picture is quite different today, but Wal-Mart’s role is no less central. As retailers like Linens ‘n Things and Circuit City head into bankruptcy and even slick operators like Target warn of a steep drop in consumer demand, customers are heading to Wal-Mart for savings. The Bentonville, Ark., based chain recently reported third quarter sales up 7.5 percent, including a surprising 3 percent gain in stores opened for more than a year.

Retail analysts tell us that many of those stores going bust right now, like Linens ‘n Things, expanded too rapidly during the good times. But Wal-Mart’s march across the United States was as energetic as other retailers’. The difference is that Wal-Mart expanded without ever losing its focus on operating efficiently, nor ever eschewed its custom of passing savings along to consumers. That’s because Wal-Mart, which produced huge savings when it revolutionized the distribution and delivery of goods to stores on a massive scale starting in the 1970s, has never forgotten the lessons that it learned during its early years. I remember in the midst of a steep recession in 1982 traveling the back roads of Arkansas to visit Wal-Mart stores and a distribution center as a young financial reporter and asking myself, “Can this really be the future of retailing?” Twenty-five years later, in the midst of another steep downturn, the answer to that question is obvious.

Still, the Wal-Mart Effect circa 2008 is different in several crucial ways. Two years ago, for instance, Wal-Mart saw an opportunity because of rising prescription drug prices, and it kicked off a campaign to sell generic drugs for $4 for a 30-day prescription. The move, which the company eventually expanded to all of its pharmacies, sparked a pricing war around the country as big pharmacy chains slashed their own prices on generics. Wal-Mart estimates that Rx customers at its stores alone have saved more than $1 billion.

That might be chump change, however, compared to what’s happening in the grocery business. Once primarily a general merchandise discounter, Wal-Mart embarked on rapid expansion of stores selling groceries when it noticed that local supermarket chains were taking a bigger and bigger bite out of consumers’ pocketbooks—in some markets doubling their profit margins during the 1990s. Today, Wal-Mart operates some 2,500 stores selling food items, and food prices at Wal-Mart’s stores are typically from 10 percent to 25 percent lower than at competitor stores, depending on the food category. Even if you don’t shop at Wal-Mart you’re likely to save five percent on your food costs when the retailer enters your market. Those savings add up, particularly for low-income households, who recognize a 6.5 percent increase in income from the savings of shopping at a big-box grocery store.

But Wal-Mart’s march into food retailing also raised the ire of powerful food unions and helped to make the chain a persistent target of labor and its political supporters. The fragmented grocery business in the U.S., where no national retailer before Wal-Mart played a significant role, is one of the few mass market sectors in which organized labor is still a force, composing about 20 percent of the workforce, compared to just five percent of general merchandise workers (Few of Wal-Mart’s general merchandise competitors, like Target or Kohl’s or Kmart, are unionized). Grocery unions have watched Wal-Mart’s entry into their business with growing alarm, which reached a crescendo during the 2004 Los Angeles area supermarket workers strike, when Democratic presidential candidate John Kerry visited the picket lines in support of workers. Although Wal-Mart was not even operating in that market, just the sight of the company rolling out its combined food/mass merchandise stores elsewhere was enough to prompt a face-off between unions and supermarkets over wages and benefits.

That battle, with Wal-Mart as the subtext during a presidential campaign, helped to galvanize every anti-Wal-Mart constituency. A disparate group united in their single-minded loathing of the chain, they ranged from anti-globalists who blame Wal-Mart for the decline in American manufacturing (as if, if Wal-Mart didn’t exist, no other retailer would have figured out consumers might be interested in buying clothes imported from overseas that cost less), to anti-sprawl activists who blame Wal-Mart for the decline of urban downtown shopping, to rural chambers of commerce, who blame Wal-Mart for the decline of Main Street shopping, to feminists who are rankled that Wal-Mart won’t force its pharmacy employees who object to the morning-after pill to dispense it (instead, those employees are allowed to pass the customer on to another Wal-Mart associate).

Members of Wal-Mart’s founding family, the descendants of Sam Walton, have also angered activists and made the business a target because they have used their fortune to support conservative and free-market causes, especially the choice movement in public education (from 2000 through 2004 Walton family members helped fund research into school choice here at the Manhattan Institute). Apparently, it’s one thing to use the family fortune to back anti-smoking initiatives in the developing world, like New York Mayor Bloomberg’s foundation has done, or to advocate for the rights of prostitutes in Africa, as George Soros’ Open Society has done, but quite another to promote free-market principles here in the U.S.

Still, despite the unique ability of Wal-Mart to drive a certain type of activist into a frenzy, consumers have mostly just yawned at the anti-Wal-Mart hysteria. Its stores remain the overwhelming shopping favorite of more Americans than any other retailer. Moreover, even in those days when unemployment in America hovered below five percent, thousands of people lined up to apply for a job when Wal-Mart opened a new store.

Wal-Mart’s contribution to American economic progress has been recognized among a diverse ideological group of economists. Most representative, perhaps, is a paper by Jason Furman, one of President-elect Obama’s economic advisors, entitled “Wal-Mart: A Progressive Success Story.” Furman acknowledges that productivity is the main engine of economic progress and that Wal-Mart has pushed much of the retail sector to follow it along a path of lower prices, benefiting low income households the most. Along the way Furman demolishes many of the typical criticisms of Wal-Mart. He notes, for instance, that calls by activists that Wal-Mart pay its entry level workers more fail to acknowledge that Wal-Mart’s overall margin of profits-to-revenues is small, as are its profits-per-worker, and that other retailers with higher salary scales serve a different, more upscale customer. Furman also disputes the notion that Wal-Mart benefits from “corporate welfare” because some of its workers (4.5 percent to be precise) are on Medicaid, noting that for entry level workers, the choice of Medicaid over a company-sponsored plan that requires co-pays simply makes economic sense, and that the benefits of the program accrue to the worker, not Wal-Mart.

Furman’s principal criticism of Wal-Mart is that as a company that serves millions of low-income households and employs so many entry-level workers, it should be doing more to advocate on the national stage for policies to help those at the bottom of the income scale, from expanding the earned income tax credit to lobbying for ways to expand health care coverage in the U.S.

Still, it’s difficult to gauge how the Wal-Mart sector, that is, the segment of retailing that includes the chain itself and every other operator forced to compete with it, will fare in the new politics of Washington. Early in the presidential campaign Obama was vying with John Edwards for the title of Wal-Mart basher, but as the campaign evolved during the financial crisis, that sort of talk evaporated.

But there is much that could be done in Washington to undermine the progressive success story that is Wal-Mart, from rising tariffs and other protectionist measures that would increase the cost of imported goods, to passage of the misnamed Employee Free Choice Act, which could set off a series of labor-management battles and prompt Wal-Mart and its competitors to rethink some of their expansion plans in the face of potentially higher employee costs. That would be the wrong kind of Wal-Mart Effect.

To survive in business, you have to make a profit. Period. Nothing else matters. General Motors, Ford and Chrysler don’t do that, so they deserve to die.

But if you want to understand why they don’t make a profit, all you need to do is look at two schemes concocted along with the United Auto Workers – the Voluntary Employee Beneficiary Association (VEBA) and the UAW Jobs Bank. The two entities work in different ways, but they have one devastating fact in common. Both require the automakers to pay billions to people who don’t do any work for them.

The VEBA, which is actually being hailed by Detroit media and civic leadership as a positive measure, is in reality a way for the UAW to protect its retirees from losing their health benefits in the event of an automaker bankruptcy. Negotiated by GM in 2007, it requires the UAW to administer retiree health benefits beginning in January 2010. That’s the part the industry’s defenders keep pointing to – the notion that it offloads retiree benefits onto the union, as if the union was going to pay these benefits out of its own pocket.

In fact, GM is required to continue spending $1.8 billion a year through the end of 2009 on retiree health benefits, while also bankrolling the VEBA to the tune of an astounding $24.1 billion so the funds are ready for the UAW to begin administering on January 1, 2010.

And that’s not all. GM will be required to make up to 20 additional annual payments of $165 million apiece in order to guarantee that retiree health benefits for UAW members are not reduced at all for 25 years. This is what the Big Three would have us believe amounts to legacy cost relief.

But even that is not as outrageous as the Jobs Bank. Established in 1984, the original purpose of the Jobs Bank was to keep workers available during temporary layoffs when the emerging technology of the time was causing short-term displacement of workers. A worker would receive 95 percent of his or her wage for up to two years – again, through a fund administered by the UAW but funded by the Big Three – until a new job opened up.

Today, of course, with the Big Three’s need for labor a fraction of what it once was, the Jobs Bank has become little more than an extended paid vacation for workers the Big Three would have us believe they have stopped paying. They haven’t. The Jobs Bank has been downsized to only 1,000 workers, compared with a whopping 12,000 as recently as 2005, but it’s still in existence, and still defended by the UAW.

UAW President Ron Gettelfinger, who is predictably coming under fire from all quarters for clinging to these perks, held an astounding news conference late last week in which he insisted that none of this has caused the problem. Again citing the struggling economy and the consumer credit crunch, Gettelfinger began howling, “It’s not our fault! It’s not our fault!”

It was an eye-opening scene, and surely illustrative for anyone who is just now getting introduced to economic thinking, Detroit-style. If my eight-year-old talked like that, I would send him to his room. In Detroit, this passes for community leadership.

Every time a parochial community defender of the Big Three insists that the rest of us just don’t understand the car business, someone really needs to tell them: When you’re desperately running out of cash and may not survive, you need to cut your labor costs now, not in two years. When you can’t make a profit on your products because you spend too much, you need to stop paying people who don’t work for you entirely, not contract out to have someone else do it for you on your dime.

No, Detroit. It’s you who doesn’t understand. Not because people haven’t been trying to warn you for decades that you were marching headlong into economic suicide, but because you didn’t want to hear it. And now your automotive bubble is about to explode and destroy you with it.

Congress would be insane to help sustain the way this industry does business. It is utter madness.

There has been a combination of events that have made the majority of the American (and I dare say European and Asian) population feel financially vulnerable. Those events include the crash of the stock and housing markets, the spiraling cost of energy as well as the ripple effect that these costs are having as they travel through the economy. Americans have seen once mighty corporations brought to their knees in short order and rapid succession. The investment banking industry is gone. If the U.S. government doesn’t belly up to the bar the American auto industry will cease to exist as it has been for decades (and might do that even if congress bellies up to the bar). The last statement is breathtaking in scope when you consider GM had been the largest car manufacturer in the world for decades, and still held the title in 2007. Yet GM has a good chance of going chapter eleven in the next couple of months.

While it is in vogue to blame the current administration for all these problems the causes are much deeper than the last eight years and are global in nature. Last time I checked George Bush wasn’t running Iceland and they are on the verge of financial collapse. These events are having a profound effect on how Americans spend their money, and that in turn will have a profound effect on the global economy.

A Confluence of Trends:

It’s a fact: if you don’t eat for a long enough period of time you die. Somewhere along the way we became an extremely prosperous country and other things such as iPods, the latest car and Adidas sneakers etc. were elevated to the level of food. We are witnessing the rediscovery that those things are not food.

My thesis can be summed up in this phrase: “You can’t take it with you and you don’t need it while you are here.” Americans are being forced to discover that they can maintain a very comfortable lifestyle while spending a lot less money. The group I am referring to is the bulk of the taxpayers who earn under $250K/ year and account for 99% of all tax payers. Uncertainty will change many “have to have its” to “I can do without it.” Looking at a brokerage account or the value of the home will no longer bring the reassurance it once did. Many (all?) will see a greatly reduced 401K. Frugality will be the watchword for the rest of this decade and much of the following. Let’s go through the list of potential casualties.

Automobiles:

The last few decades have seen a tremendous improvement in the reliability and longevity of cars. Many new car purchases are made not out of necessity; they are a gadget or luxury upgrade. But the trade-in was not replaced because it had to be but because the owner wanted the latest greatest vehicle with the smell of new leather. Americans looking to get out from under a car payment will realize that they can keep their current automobile for twice the length of time they had in the past. In the last few weeks auto sales have cratered and it is my contention they won’t be back anytime soon. People will drive less, car pool more, drive slower and in general do the things that will make their cars last longer.

Once in this mode of thinking, reversion back to the days of old will take many years. Don’t expect a sustained uptick in auto sales anytime soon. In anticipation Toyota, nominally as well run an auto company as any, is planning a 30% reduction in output. It won’t be alone and it won’t be enough.

Last time I checked autos were crammed with electronics such as engine controls, radios etc. Fewer auto sales will have a large impact on semiconductor companies, particularly those that make data conversion devices, high power semiconductors and solid state sensors. Dealerships will go under (that’s already happening), parts suppliers will suffer and metal manufacturers will face severe cutbacks.

Housing & Real Estate:

The housing bust continues unabated. The house as piggy bank is effectively dead and with it goes the ready source of cash. I’ve rarely been to a house where its occupants say they have enough room and would/will gladly trade up as soon as they are able. Mostly of those houses had ample room; it was a state of mind that the house seemed too small. People will make do and that will slow down new house sales as well as house swapping. Moving from house A to B always entails major expenses and typically new appliance purchases. But major appliances like autos last virtually forever and people will discover they absolutely don’t need that new dishwasher etc. Recently Lowe’s reported disappointing earnings and one of the culprits was a major slowdown in major appliance sales.

Who gets hit by this? Well we’ve already seen Circuit City bite the dust and no doubt some mom and pop appliance places will feel the heat (or lack thereof). Semiconductors and metal manufacturers will see reduced sales. No doubt some real estate sales offices will go under. One or two of the major home builders will tank. Less construction equipment will be needed.

The point is that Americans will find that they can easily make do with much of what they have already. And once in that mentality it will be quite a while before the spending habits of old will return. There will be more kids living with their parents for a longer period of time, slowing housing growth. Lastly that ready source of easy cash to buy luxury items is gone and with it the sales of those items.

Commercial real-estate will also be hit. Businesses will contract and there will be downsizing of space requirements as the pressures to save energy and time usher in growth in the electronic remote office.

Electronics:

I personally have refused to buy Windows Vista and it appears I am not alone. PC sales growth will continue to decline because most of the changes are evolutionary and not revolutionary. Users will replace what breaks. As their children age and require new computers for school they will get low-end machines which are more than adequate for schoolwork. The biggest performance boost I can get for my computer is increased Internet speed flowed by increasing the amount of DRAM my machine has. Beyond that, everything else costs much and delivers relatively little.

Flat screen sales have been hammered recently. And as cheap as they have become, millions of viewers have still opted to buy the digital converter box for their TVs for 15 bucks rather than fork over a couple of hundred dollars for a new set. The march to high definition and Blue Ray, while inevitable, will be greatly slowed down for the simple reason that it isn’t necessary. When the house was a piggy bank such luxury purchases did not seem extravagant.

Losers include the semiconductor companies (once again), Microsoft and all the ancillary software you need to buy to have a functioning PC such as anti-spyware and virus software.
I believe the cable companies will be a beneficiary.

Travel:

Videoconferencing use had been growing prior to the energy bubble and now is being deployed at ever accelerating speed. Cisco has championed its use and has shown how it has enhanced its own bottom line by travel cost containment. Many corporations will have to follow. And if your competitor gets an edge over your business you will be obliged to follow suit. The quality, reliability and cost of new systems combined with the increased price and time of travel may yet make this trend “viral.”

Systems will soon be available (Cisco announced a box coming in 6 months) that turn your TV and internet connection into a high quality VC experience. This will displace some family travel plans. Losers include hotels, motels and higher end restaurants and clothiers.

Miscellaneous Luxuries:

Starbucks stock began to tank in 2007 and that presaged a dramatic decline is sales. People are cutting back and have learned they can live OK without a super duper latte. Designer clothes will give way to Wal-Mart specials. You get the idea.

Bottom Line:

Unlike other financial eras in American history, we’ve been buying many items ranging from cars to houses and electronics which were nice to have but not a necessity. The last bunch of weeks essentially wiped out the gains of this century in the stock market and it is pretty clear the bad news on corporate profits won’t end any time soon. Americans will learn that they can live without many things, and this retrenchment in spending has started to filter through the economy here and abroad. The power of making do will take hold and binge spending will take a long time to come back.

At a wonderful dinner last night I had a chance to talk to Nobel Prize-winning economist Robert Mundell about all things economic. What is to be done? I asked him.

Mundell, you may remember, was a leading supply-sider in the Reagan revolution. He argued for low marginal tax rates to spur the economy and a stable dollar to eliminate inflation. Bob Mundell also is the father of the euro. He is plainly an incredibly brilliant and distinguished man.

The dinner was put together by the indefatigable hard-money analyst Judy Shelton, a pretty smart gal herself. Our spouses were there along with some friends.

So here’s Mundell’s latest take on a pro-recovery, fiscal-monetary, growth mix. First, he’d like to see a complete corporate tax holiday for one year. He then favors corporate tax reform that would drop the current top rate from 35 percent to 15 or 20 percent. He believes this would generate badly needed business investment and job-creation to fight recession.

Incidentally, in today’s durable-goods business-investment report for October, capital-goods shipments are falling at a 12 percent annual rate versus their third-quarter average. Orders are down 35 percent. (By the way, that third-quarter average was a negative number.)

So Mundell is clearly on to something. Business needs help. Without healthy business, there will be no significant new job creation or consumer spending power.

On money, Mundell had two interesting thoughts: First, the U.S. dollar and the Chinese yuan should basically be re-linked at roughly today’s exchange rate (about 6.8 yuan to the dollar). There should be no more Chinese currency appreciation. Incidentally, Mundell thinks the Chinese economy is actually in some trouble. And he’d know. Mundell travels to China about once every other month as a key advisor to the Bank of China.

Also on the currency front, Mundell would prefer a floor under the euro at roughly $1.25. That’s about where it is today. It’s also roughly the same as the original $1.18 euro initial public offering in 2000. So Mundell is pressing for dollar stability relative to Europe and China. And he believes that would be consistent with domestic price stability here at home.

Unfortunately, Fed head Ben Bernanke simply doesn’t think in these global currency terms. Mundell has no real problem with the Fed’s huge balance-sheet expansion to push new cash into the credit-crunched recessionary economy. He believes there is a huge demand for dollars at home and overseas, and that the Fed should be accommodating this.

But Mundell frets that Bernanke is too much of a Phillips-curve unemployment-rate targeter, and that he doesn’t understand the powerful influence of a sound currency policy.

Putting it all together, Mundell’s anti-recession program is a reduction of the high marginal tax rate on business to reignite growth along with a stable dollar to contain inflation.

We also got around to talking about Paul Volcker, who is a friend of Mundell’s. He’s also my former boss from 1975, back when I was a young staffer at the New York Fed and Paul Volcker was the bank’s new president.

Volcker, of course, has been counseling Barack Obama during the financial crunch. And today, the president-elect appointed Volcker, the former Fed chair, to be the head of a new White House advisory board on the economy. This advisory board takes a page from Ronald Reagan, who set up PEPAB, the President’s Economic Policy Advisory Board, back in 1981. Members of that group included Milton Friedman, Art Laffer, Alan Greenspan, Arthur Burns, Herb Stein, and others. George Schultz was the first chairman. This group helped sustain Reagan’s supply-side policies during some difficult times in 1981-82.

Now, no one really knows what Paul Volcker really thinks about the myriad TARP financial-rescue packages being run by the Treasury, the Fed, and the FDIC. Nor do we know what Volcker thinks about the Fed’s ballooning balance sheet, or U.S. dollar policy for that matter. A lifelong Democrat, Volcker is properly credited with slaying inflation in the 1980s. But he is no supply-sider.

Presumably, however, the conservative-Keynesian Volcker, along with Tim Geithner, Larry Summers, and Christina Romer, will advise Obama not to hike taxes in the next two years.

But that’s a presumption. We don’t know who else will be on this Obama economic advisory board. Might they consider a stable dollar and a big corporate tax cut? Well, if Volcker listens to his friend Mundell, he’ll gain some important advice to be passed along to the new president-elect.