HEEDLESS GOVERNMENT

Once Again the Problem, Not the Answer

FUTURECASTS online magazine
www.futurecasts.com
Vol. 4, No. 10, 10/1/02.

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Facilitating commerce:

 

In the 1970s, left wing efforts to blame the economic system failed.

  In the 1930s, left wing propaganda was able to blame the capitalist economic system for a Great Depression that was actually caused by government policies of incredible stupidity. However, in the 1970s it became widespread knowledge that the vicious swings of the business cycle and stagflation suffered during that decade could only be caused by government. In the 1970s, the left wing failed to sell their anti-capitalism propaganda line of blaming the economic system for economic ills caused by government.
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  In the 1970s, it became obvious that government was the problem, not the answer. That inflation and stagflation are always the responsibility of the monetary authorities - the government - is an obvious fact, and by 1978, incumbent left wing politicians were feeling the ire of the electorate.
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  As a result, reform of economic policies to facilitate profit driven, market directed commerce
was a central feature of government policy from the last two years of the Carter administration until the last two years of the Clinton administration. There is nothing like a credible threat to incumbency to concentrate political minds.
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  In the U.S. - and around the world - deregulation, privatization, and tax reforms and reductions became the order of the day. Socialist systems crumbled, market systems spread, and the U.S. economy slowly struggled out of the morass of the 1970s - ultimately surging upwards in the last half of the 1990s.
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The triumph of political expediency over national interest:

  However, there has been a major casualty of this extended period of prosperity. The political pressure to improve the political environment for commerce has materially receded. There are few efforts any more to remove government burdens on the economy or prevent taxes, regulations and other government activities from creating economic and financial distortions.
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Thus, political expediency increasingly triumphs at the expense of the national interest. Now, the predominant political pressures are to buy votes at the expense of the economy and the public treasury.

 

An intellectual tone accepting of vast new regulatory initiatives and entitlements and other welfare and special interest programs has been established.

   Politics is often dominated by small groups fighting for gains that are highly concentrated - frequently at even inordinate costs. But these costs are so widely shared as to be imperceptible to the individual members of the public.
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  Thus, political expediency increasingly triumphs at the expense of the national interest. Now, the predominant political pressures are to buy votes at the expense of the economy and the public treasury. The size and expense of government - and the economic burdens it imposes - are increasing explosively. As a result, the U.S. is again headed towards problems similar to those of the 1970s - but hopefully not so severe.

  It is ironic that - just as the public is beginning to put aside its skepticism about government - just as a burst of patriotism is lifting the public esteem for government - government is again failing the national interest in favor of narrow political and ideological interests.

  On the left, old socialists and advocates of government "industrial policy," - their old ideological positions no longer tenable - have adopted a fall back position in favor of the entitlement welfare state. Where once they sagely pointed out all the weaknesses and instabilities of capitalism, they now preach about the strength and stability of capitalism - and its undoubted capacity to bear the burdens of vast entitlements and heavy regulatory burdens.
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  The left wing ideologues were not only wrong before - they are indubitably wrong now. Capitalism is certainly a sturdy system - a hardy weed that keeps coming back no matter how often it is trampled upon. However, it thrives only with good governance that facilitates profit driven, market directed commerce. Without that, it struggles or dies back.
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  Whether fully believed or not, this new propaganda line from the left has set an intellectual tone accepting of vast new regulatory initiatives and entitlements and other welfare and special interest programs. Political attitudes that take economic strength for granted now guide politics. Since 1999, Congress and federal regulators have been heedlessly piling additional burdens upon the economy.
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It is the pressure for capital gains that has driven most of the recent accounting scandals.

  Of course, this is a substantial change of emphasis - not a 180 degree change of course. Congress and the SEC, for example, are busy with the important task of assuring transparency of financial disclosures - trying to accomplish with additional regulations what would be better achieved if the tax system had not destroyed the attractiveness of dividends as the primary form of return on investment. It is the pressure for capital gains that has driven most of the recent accounting scandals. And Pres. Bush has at long last been provided with fast track trade negotiating authority - although burdened with special interest environmental and labor conditions and various protectionist measures.

  Congress is "shocked - shocked" at the SEC's failure to avoid recent blatant accounting excesses driven by pressures to achieve capital gains. Somehow, none of the Congressmen waxing indignant about this failure care to mention that - prior to the development of the current scandals - Congress threatened the Clinton administration SEC with a cutoff of funds if it continued its efforts to deal with the accounting problems.

Disdain for priorities, burdens and consequences:

  Vast new regulatory burdens were imposed on the economy during the last two years of the Clinton administration. State and local government spending soared in response to the flood of new revenues produced by the prosperity of the 1990s - heedless of the inevitability of the business cycle.
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In Congress and the Bush administration, there is almost total unconcern for the massive new burdens being heaped upon the economy.  The door is open for all kinds of social and pork barrel programs.

  And now, the lid on federal spending has been lifted by the War on Terrorism. In Congress and the Bush administration, there is almost total unconcern for the massive new burdens being heaped upon the economy.  The door is open for all kinds of social and pork barrel programs, driving a potentially disastrous increase in the government sector as a percentage of the entire economy. Until the recent passage of "fast track" trade negotiating authority - the results of which remain to be seen - progress towards international trade liberalization slowed and in some cases was reversed.
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  And the abysmal system of federal taxation was continuously elaborated during the Clinton administration - strengthening and expanding a host of noxious tax incentives undermining the vigor and stability of the economy. Recent modest tax decreases only slightly improve matters - and most of them don't take effect for some years yet. Demagoguery and envy of the rich conspire to convince people to shoot themselves in the foot - repeatedly.
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  Needless to say, the current mild economic recession has not been enough to get the attention of our current political leadership. If that remains the case, we can expect the market to inexorably deliver increasingly stern lessons during subsequent downward phases of the business cycle.
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There is as usual no indication of any recognition of budget constraints and the need for priorities - much less any rational effort to follow them. There is determined ignorance of unintended consequences.

  Of course, the advocates of the many regulations and social and pork barrel programs can all put forth reasons for these actions - and some of their arguments actually have some validity. Of course, the social engineers never tire of elaborating the tax statute in pursuit of their noble ends. Unfortunately, there is as usual no indication of any recognition of budget constraints and the need for priorities - much less any rational effort to follow them. There is determined ignorance of unintended consequences.
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  However, it's the economy that provides the trolley car. If the economy staggers under its many burdens, all manner of programs will fail, and all manner of additional problems will arise. It is, indeed, the economy, stupid!
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Accumulating burdens on commerce:

  And the burdens are indeed of visibly staggering proportions. Here are some samples.

Industrial and agricultural dinosaurs are being kept alive by massive subsidies and protectionist restraints on trade - thus blocking the process of creative destruction that is so essential to a healthy capitalist system.

 

Because of those noxious tax incentives, no amount of regulatory red tape will prevent the inflation once again of the capital asset bubble and continued expansion of the debt bubble.

 

It doesn't take a rocket scientist to realize that these programs - doubling in cost about every six years - will within the lifetime of many of today's young absorb all the financial resources in the universe.

 

Liability and casualty insurance rates for professionals, executives, and businesses of all kinds are soaring. Health care insurance cost increases are forcing many businesses to cut back on health benefits offered.

  • Make no mistake about it - the terrorists achieved significant objectives in their attack. Heightened risks and increased costs are real burdens for the economy to bear. Even without further attacks, the constant subsequent alarums and the costs for the proliferating security procedures and vast security apparatus are real blows to the economy. The constant alarums and war talk - along with legitimate doubts about the validity of accounting figures - has increased perceived risks and investor skepticism and turned the stock market into a lagging indicator instead of a leading indicator. This has materially increased the difficulty and expense of raising equity capital.

  • With tax laws that now make housing the premier tax shelter, the inflation of a vast housing bubble should surprise nobody. People are building as much house as they can afford - some putting 3,500-to-5,500 square foot mansions ridiculously on lots of just about a half acre. Money is being poured into second and third homes. Low interest rates encourage the assumption of large mortgages. It will take a substantial recession to prick this bubble - but a substantial recession does indeed seem increasingly likely within the next couple of spins of the business cycle.

  • Among the factors driving the housing price bubble is the increasing array of regulatory obstacles facing home builders. In some markets, one third of the cost of a new home is attributable to regulations, and the duration and uncertainty of the regulatory process has driven small developers out of many major housing markets. This leaves the field to the larger developers who have the financial strength to push their developments through and pass on the costs to the home buyers. This, of course, also pushes up prices of existing homes.

  • The recent mild recession has let considerable air out of the capital asset bubble. However, the debt bubble - also driven by those noxious tax incentives - keeps growing in the U.S. - and even more in Europe. While interest rates keep declining, there has been an adverse credit shift. This reduces the number of investment grade borrowers, shrinks the high yield corporate bond market. contracts the commercial paper market, and forces increasing reliance on bank lending.

  • Industrial and agricultural dinosaurs are being kept alive by massive subsidies and protectionist restraints on trade - thus blocking the process of creative destruction that is so essential to a healthy capitalist system. As FUTURECASTS has repeatedly stated, the right to fail is as important as the right to succeed. 

  • New increases in regulatory red tape and liability threats will do little to overcome the noxious incentives in a tax system that harshly penalizes equity capital and dividend payments. The costs for accounting services and financial reporting soar. From vast multinational corporations to each individual citizen, both the money and time wasted in tax preparation soar. A Byzantine tax system undermines compliance and respect for the law. And because of those noxious tax incentives, no amount of regulatory red tape will prevent the inflation once again of the capital asset bubble and continued expansion of the debt bubble.

  • Noxious tax incentives that favor capital gains and punish dividends not only facilitate accounting fraud, they also greatly increase stock market volatility. The value of dividend paying shares can stay fairly stable for long periods of time. However, shares that primarily provide their return on investment in the form of capital gains lose all their attractiveness as soon as prospects for further price increases fade. Earnings are matters of opinion - cash dividends are statements of fact!

  • The nation's vast entitlement programs increasingly loom as major problems. Demagoguery has prevented our brilliant political leaders from even addressing recognized problems in Social Security and Medicare. Reasonable policies could deal with the problems with Social Security - if they could be implemented. While there are now fewer workers for each Social Security recipient than in the past, the productivity of each modern worker far exceeds those of the past. The population is indeed aging, but the average period of fragility is not increasing anywhere near as quickly. The resources to provide for the elderly at reasonable levels will be there - but only if reasonable policies are adopted.

  • Medicare and Medicaid and other third party payer health care systems are once again experiencing double digit price increases. Medicare and Medicaid together currently cost federal and state governments in excess of $400 billion. Approximately one third of these costs are not for health care but for the administrative costs of these third party payer systems. Waste, fraud and abuse consume tens of billions of dollars. It doesn't take a rocket scientist to realize that these programs - doubling in cost about every six years - will within the lifetime of many of today's young absorb all the financial resources in the universe. The system will, of course, break down long before that - after first deteriorating into rationed medical care.

  • Incredibly, political and ideological pressures are now accelerating the inevitable breakdown by loading these programs with additional major entitlements. There is a determined ignorance of reality among those driving health care policy. Their objectives are too noble - and political expediency too attractive - to be constrained by reality.

  • The bulk of the middle class and the lower economic strata are increasingly being herded into mass health care systems. For all the scientific tools, the delivery of health care is still a practical art - a clinical art. Doctors who can't spend time with patients cannot competently deliver health care except in the most obvious cases. In many instances, by the time a problem becomes evident in their tests, the patient is half dead. For third party payers, the restraint of costs is far more important than quality of service. Understaffing at all levels is becoming an increasingly serious problem. Of course, the wealthy and the upper middle class will continue to be able to buy the health care they need.

  • Insurance rates provide an unobstructed view of reality. Liability and casualty insurance rates for professionals, executives, and businesses of all kinds are soaring. Health care insurance cost increases are forcing many businesses to cut back on health benefits offered. All of these costs ultimately get passed on to the consumer - but not before taking a toll on weaker business entities. Third party payer systems begin to break down just as they drive costs up so high that almost everybody is dependent on them.

  • California - the state with the nation's largest economy - is being turned into a regulatory basket case by a runaway liberal legislature and heedless governor. Smoke and mirrors can cover up most of their budget problems this election year, but next year, it will really hit the fan. California may again become a state known to be unfriendly to business - and may again - as during the last state democratic administration - suffer from a lagging economy.

  • Even the nation's foreign policy is afflicted by serious economic policy failures. Restraints on imports from poor nations - especially agricultural, textile and apparel restraints - are having serious impacts in Latin America, Africa, and in strategically important Pakistan. Vast aid programs and financial bailouts are financial burdens, but trade is a win-win proposition - benefiting both importer and exporter. Unfortunately, narrow special interests keep trumping the broader national interest in liberalized trade.

  • Governance problems among the Asian Tigers and Latin American nations persist. Argentina is just the latest victim. Governance problems in Japan are still only marginally being addressed, and its financial fundamentals continue to ominously deteriorate. The regulation producing machinery in Brussels continues to wind more red tape around the European Community economy, in addition to increases in regulatory burdens coming from many of the individual nations. As a result, costs increase and economic flexibility declines - and the world is again dependent on the U.S. to provide the major engine for economic growth.

The turbulence in our future:

 

 

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  This next period of recovery and prosperity should be just fine - if more restrained than during the 1990s. We start with interest rates at the lowest levels in half a century - although an adverse credit shift has raised interest costs for many private borrowers. The recession has in fact been sufficient to force wide ranging rationalization of private sector business plans that will produce considerable benefits. The private sector does not require depression or severe inflation to induce it to mend its ways - as is the case with government.
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The two decade long period of accelerating prosperity is now over.

  And the nation's banking system has not been seriously impacted by this mild recession. Unlike in Japan and many other nations, U.S. banks do not have substantial stock holdings. They took some hits to their loan portfolio, of course, and there has been observable deterioration in the quality of their loans, but the collapsed dot-coms had few tangible assets and so were not able to borrow very much from the banks.
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  Nevertheless, the two decade long period of accelerating prosperity that the U.S. has enjoyed - only interrupted by short, mild recessions a decade apart - is now over.
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There are serious economic difficulties in the nation's future that could last for considerable lengths of time - depending on the extent of stubborn stupidity of the nation's political leaders.

  Except for people who have a long investment time horizon in excess of at least 15 years, the old comfortable buy and hold investment strategy that has worked so well in the last two decades will no longer suffice. There are serious economic difficulties in the nation's future that could last for considerable lengths of time - depending on the extent of stubborn stupidity of the nation's political leaders.
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  As this period of prosperity proceeds, investors without very long time horizons will have to take profits and find safe places to put their capital. Government bonds will suffice if there is no inflation - but not if inflation becomes a part of the problem. Then, inflation indexed bonds might gain in attractiveness along with traditional inflation hedges.
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Despite the well publicized shift to budgetary deficits at all levels of government - and a vast acceleration of monetary expansion - the economic recovery remains sluggish. The predictable Keynesian excuse is that there simply hasn't been enough government deficits and monetary expansion. Well - as was demonstrated in the 1970s - there never is!

  It may seem strange to raise concerns about inflation at a time when inflation is nowhere in sight. However, FUTURECASTS strives to be ahead of the curve. The current mild recession is yesterday's news - and the recovery is today's news. The nature of the next period of economic difficulties is tomorrow's news - which is what FUTURECASTS strives to present.
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  It remains to be seen whether inflation will again become a part of the nation's economic problems - thus making our future economic problems as severe as those of the 1970s. Political pressures to resort to Keynesian palliatives of budgetary deficits and accelerated monetary expansion will be increasingly compelling as politicians strive to put off having to deal with politically and ideologically difficult problems.
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  Already, Keynesians like Paul Krugman are strenuously pushing accelerated monetary expansion as the remedy of choice to prevent future economic reversals - and even to juice up the current sluggish recovery. Despite the well publicized shift to budgetary deficits at all levels of government - and the lowest interest rates in many decades - the economic recovery remains sluggish. The predictable Keynesian excuse is that there simply hasn't been enough government deficits and monetary expansion. Well - as was demonstrated in the 1970s - there never is!
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Inflation  invariably creates vast additional problems of its own - and always imposes the prospect of an austerity depression - such as in 1980-1982 - as a prerequisite to any relief.

  The impressive list of budgetary, regulatory and tax burdens that are the fundamental causes of the coming economic difficulties cannot be dealt with by the standard Keynesian palliatives. The particular problems must be confronted and reformed. This is at best a difficult political task that will be much easier without inflation than with inflation.
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  Inflation, after all,  invariably creates vast additional problems of its own - and always imposes the daunting prospect of an austerity depression - such as in 1980-1982 - as a prerequisite to any relief.

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Copyright 2002 Dan Blatt