I’ve been a follower of economics since I had the opportunity to try to understand America.  I immigrated from Italy as a 10 year old, and everything was “new” to me.  In school I strived to understand cause and effect.  Having studied economics for almost 50 years, this article best describes how I feel about it all.  Enjoy!

Conservatives should never say to voters, “We can lower your taxes.”  Conservatives should say to voters, “You can raise spending.  You, the electorate, can, if you choose, have an infinite number of elaborate and expensive government programs.  But we, the government, will have to pay for those programs.  We have three ways to pay.

“We can inflate the currency, destroying your ability to plan for the future, wrecking the nation’s culture of thrift and common sense, and giving free rein to scallywags to borrow money for worthless scams and pay it back 10 cents on the dollar.

“We can raise taxes.  If the taxes are levied across the board, money will be taken from everyone’s pocket, the economy will stagnate, and the poorest and least advantaged will be harmed the most.  If the taxes are levied only on the wealthy, money will be taken from wealthy people’s pockets, hampering their capacity to make loans and investments, the economy will stagnate, and the poorest and the least advantaged will be harmed the most.

“And we can borrow, building up a massive national debt.  This will cause all of the above things to happen plus it will fund Red Chinese nuclear submarines that will be popping up in San Francisco Bay to get some decent Szechwan take-out.”

Yes, this would make for longer and less pithy stump speeches.  But we’d be showing ourselves to be men and women of principle.  It might cost us, short-term.  We might get knocked down for not whoring after bioenergy votes in the Iowa caucuses.  But at least we wouldn’t land on our scruples.  And we could get up again with dignity intact, dust ourselves off, and take another punch at the liberal bully-boys who want to snatch the citizenry’s freedom and tuck that freedom, like a trophy feather, into the hatbands of their greasy political bowlers.”

~ From The Weekly Standard

 Hat Tip:  Adventures in Capitalism

This is unbelievable, but it is good news:

WASHINGTON - House Speaker Nancy Pelosi told the Wall Street Journal that she is considering a two-staged effort to boost the shaky U.S. economy, arguing for action now on a stimulus package of $60 billion to $100 billion, followed early next year by a companion measure that would include a “permanent tax cut.”

In an interview Thursday morning, the California Democrat pointed to weakness in the nation’s jobs market, and urged the White House, long skeptical of Democratic-led stimulus efforts, to work with Congress in the waning days of President Bush’s term.

“Let’s see if we can’t do something, working together now, that gives us a two month jump,” she said.  She said any measure enacted in a lame-duck session of Congress this month would effectively be a downpayment on additional measures enacted later.  “We’ll take the longer view as soon as we take over in January.”

Ms. Pelosi said she doesn’t favor a capital gains tax cut, as pushed by congressional Republicans.  But she did say the “second piece” of the Democratic stimulus agenda should include a tax cut.

The speaker said she prefers a direct tax cut over tax rebate like the one pushed by President George W. Bush a year ago.  The speaker said a direct tax cut can have a more immediate impact on the economy, especially if the government adjusts tax withholding tables to speed dollars into worker paychecks.  “The impact is faster than a rebate, which takes a few months get into people’s hands,” she said in an interview.

 ~ From Thursday’s Wall Street Journal

The election is done.  Time to focus on the upcoming recovery in the stock market and economy. 

Here is what I see happening. 

Let’s first look at monetary policy.  As seen in the below chart, the Fed is pumping massive amounts of liquidity into the financial system:

 
 
After a period of time banks will be saturated with lendable dollars and bankers will start looking for deals.  Instead of being incredibly defensive, they will be on the lookout for borrowers.  There are a lot of good ideas out there but the owners of these ideas need capital to bring them to market.  Growth has been held down by a sharp decline in velocity (the rate at which money changes hands) and fear. 

I expect this activity to slowly increase just from the fact that more money is being made available.  The problem during the credit meltdown was there were a lot of people with ample collateral but could not get approved for a loan. 

So are we close to the market bottom?

Hindsight is the only way to be certain but one indicator that tells me we are nearing a recovery is business inventories.  They’re way down because everyone has been holding back thanks partly to the media spreading recession/depression fears for the past year and a half. 

This tells me companies will eventually need to start producing more goods.  When they do start producing, activity rises as does GDP.  I could be wrong but my best guess is that by the spring of next year we will begin to see the visible traces of growth.   

Now on to fiscal policy - the taxation and spending that goes on in Washington. 

We have an idea of what our President-Elect wants to do but the real issue is what will he do.  Fortunately the high level advisors to Obama carry a lot brain power - especially former Fed Chairman Paul Volcker.  So I don’t expect anything disastrous to happen, just slower growth (than what a free market would produce) once policies are put in place.

As for the stock market recovery, I think it will be closer to a V shape.  Actually, there will be two recoveries - one in the stock market and the other in the economy but we will see the market recovery first. 

Here’s why:

Unemployment is a lagging indicator meaning the peak of joblessness is seen after a market bottom has passed.  A ramp up in business activity and production will not be seen in current jobless claim reports. 

Historically a stock market recovery takes off at least 6 months prior to a recovery in the economy.  Expect the economic recovery to be more U shaped as the economy continues to muddle along over the next few months.       

I will close this post with the following:  My advice to investors over the past several months remains unchanged.  The rate at which the Fed is creating money will eventually have some incredibly powerful effects on asset prices.  When will this be?  Impossible to say but what I am most certain of is that you will either be a net receiver or a net payer.  Buyers of tangible assets at today’s prices will find themselves on the receiving end once the market recovery arrives. 

In case you missed John Stossel’s “Politically Incorrect Guide to Politics” that aired last Friday on 20/20, it is now available on YouTube.  Here is the first part:

Part 2 is here, part 3 is here, part 4 is here, part 5 is here, and part 6 is here. 

We are currently in the grip of a temporary deflationary panic but based on the evidence I see from the Federal Reserve and its growth of the money supply, the long term trend is still inflationary and owners of tangible (non dollar-denominated) assets will be the winners at the end of this shakeout.  It’s disconcerting to see our portfolio values drop but being a diversified owner is still the best place to be if real world safety is your goal.

Bottom line:  I’m a buyer and not a seller.  And now is the time to be making financial decisions with your head, not your heart.

Update:  A transcript is linked below.

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Lots of silly arguments on the economy are being made from both sides of the political aisle.  Here are some (slightly altered) paragraphs from an article I wrote last January to clarify the conventional thinking:

The infusion of what is called “loose money” is always a stimulating consequence for the economy in the short term.  The analogy I often use is pumping oxygenated blood into your body.

The downside to the Federal Reserve’s ability to create money out of nothing does cause malinvestment of capital as we’ve witnessed with the housing and banking fallouts.

Long term, creating money without limit always leads to increased prices and less buying power, which is a problem for people with the bulk of their financial assets in bonds, bank CDs, and other dollar-denominated investments.

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Dr. Mark Perry and Brian Wesbury are both very good economists that I like.  This past week the two have been going back and forth on the concerns of inflation. 

On Tuesday Brian wrote this editorial in the Wall Street Journal.  Here are a few highlights:

Today’s problems began seven years ago in 2001, when the Federal Reserve overreacted to the deflationary mistake it made in the late 1990s.  The Fed vigorously pumped money into the economy in order to drive interest rates down rapidly. 

As is so often the case, after the Fed has acted, but before the typical lag in monetary policy has fully played out, conventional wisdom argues that the Fed has become impotent.

. . .

One of the reasons that monetary policy is so loose today is that our economy is addicted once again to easy money and low interest rates.  We hear over and over that the Fed cannot tighten because the housing market and the economy are vulnerable.  This was the same argument made in the pre-Volcker 1970s, when the U.S. bounced from one economic crisis to the next.

Shortly after, Mark countered with this post on his blog and then he added another post to address Brian’s comments.        

My Thoughts:  Both arguments have validity, hence, in the short term, I can argue either way.  In the long term, politicians will be politicians, and as long as there is no restraint (such as a gold standard) there WILL be inflation because it’s a hidden tax, and politicians will take advantage of it. 

According to the “Wall Street Journal,” Washington is teeing up “the rich” for a big tax hike next year, as a way to make them “pay their fair share.”  Well, the latest IRS data have arrived on who paid what share of income taxes in 2006, and it’s going to be hard for the rich to pay any more than they already do.  The data show that the 2003 Bush tax cuts caused what may be the biggest increase in tax payments by the rich in American history.

The nearby chart shows that the top 1% of taxpayers, those who earn above $388,806, paid 40% of all income taxes in 2006, the highest share in at least 40 years.  The top 10% in income, those earning more than $108,904, paid 71%.  Barack Obama says he’s going to cut taxes for those at the bottom, but that’s also going to be a challenge because Americans with an income below the median paid a record low 2.9% of all income taxes, while the top 50% paid 97.1%.  Perhaps he thinks half the country should pay all the taxes to support the other half.   

Aha, we are told: The rich paid more taxes because they made a greater share of the money.  That is true.  The top 1% earned 22% of all reported income.  But they also paid a share of taxes not far from double their share of income.  In other words, the tax code is already steeply progressive. 

My Thoughts:  The average American today works from January 1 to July 16 just to pay for government before they begin working for themselves.  Isn’t it ironic that just a few weeks ago we celebrated the Fourth of July, a national holiday that honors early Americans who rejected an oppressive tax system?

 Giving a whole new meaning to the number 1776 . . .

 From Chris Edwards at the Cato-at-liberty blog.