Tuesday, November 04, 2008


Your are right about the market, of course, but I am not looking for short term gains. The stock market does well during years of stimulative tax and spend policies, whether that money is spent on wars or domestic programs. The short term moves of the stock market are not the correct gauge to measure the economics or the morality of any particular policy.

The FOMC Chairman under Bush, kept interest rates artificially low after the economy recovered from the 2001 recession, Bush spent tons of money on the war and stocks soared. On the other hand, Clinton, after two years of stumbling around, did a great job of leading a republican congress down an excellent domestic path: stocks soared. Unfortunately, the President and his team did not ever take their collective feet off the economic accelerators. By the end of the Clinton term, stocks soared to ridiculous and unsustainable levels. It was not the good times in the stock market that made the Clinton term a successful term (at least as far as domestic policies go). Had Clinton gotten fired up about the risks of international terror and tightened our economic belt in order to "nip terrorism in the bud" the economy would not have over heated and wars might have been prevented.

As detailed in other messages, in recent weeks, the FOMC has increased its reserve balance sheet at an unprecedented rate. The Fed Funds Rate is at 1% and the 90 day t-bill has been trading under .4% and as low as .08%. With that kind of gasoline being poured on the economic bond fire, we do not need to worry about stocks.

It is easy for the FOMC to make stocks go up or down in the short run. When the FOMC tightened too rapidly in the summer of 1987, the market crashed. The FOMC opened the flood gates to the money supply and stocks rapidly recovered. What is hard is for congress to stick to principle. What is hard is to avoid corruption. One of the necessary components of a stable society is the rule of law. We are in a dangerous position when we return to power those who consistently pass laws that benefit special interest groups rather than society at large.

The recent bail out bill was hammered through by a republican treasury secretary. It had no chance of passage though a principled congress. The administration had the power to act but instead it twisted the arms of congress to add power to the the executive branch. The bailout was passed by a democratic congress that has long been in the habit of passing bills that benefit special interest. After the bailout was passed, a bill that transferred great wealth to the few and one that gave the treasury secretary great power to pick winners and losers, the financial system was "saved" by methods already available to the treasury and the FOMC. Instead of giving all banks relief from capital requirements, the Treasury Secretary negotiated relief for selected banks. Once this was done, the FOMC "saved the day" by flooding the system with liquidity.

The market rally has been modest thus far but conditions are ripe for a strong recovery in real estate and in the stock market. This has nothing at all to do with the fact that Obama's proposed economic policies are not the best for the long term prosperity of the country. We know that the majority believe things that are simply not true. For example, the majority believe that increases in the minimum wage help the poor.

The subsidies for ethanol helped push up the price of many ethanol companies. This did not make the ethanol any better. Many of these companies are now bankrupt. At the same time, scientist can see great potential in "elephant grass" and other cellulostic fuel substitutes. If Obama tries to force feed the energy baby, the way the past congress and administration tried to do, they will waste a lot of hard earned dollars. They will take these dollars from the most productive places and move them to the most non productive places.

The situation is the exact one described by the story of Henry Hazlitt's broken bakery shop window. Henry wrote "Economics in One Lesson", "The Foundations of Morality" and other noted works. In chapter two of "Economics in One Lesson" he tells the story of the broken shop window.

You probably remember the story but, just in case, it goes something like this. A young hoodlum throws a brick through the bakery shop window. The baker chases the kid but can't catch him. A crowd gathers and comforts the shop keeper. After a time a few of the other shop keepers have gotten quite philosophical about the bakers loss. The glacier is first to realize that a $200 window is about to be ordered. He mentions to the bar tender that he should be able to pay up his tab and before long the young hoodlum has almost become a hero. Through the trickle down effect, so despised by Obama, the whole town soon realizes that everyone is going to be better off as a result of the extra spending caused by the hoodlum.

From the eyes of the populist crowd, the hoodlum is the good guy and the rich baker got what was coming to him. The baker can afford it and even if he must borrow the money he will make it up in time.

It so happens that the tailor was not in the crowd, but, had he been, he would not have been aware that the baker was planning to buy a $200 suit. He will never know because the baker will defer the purchase until he has once again saved up $200.

The towns people do not see the trickle down from the purchase of the suit but instead from the purchase of the broken window. The economic loss to the community is the $200 loss incurred by the baker. In the short run, the town saw the stimulative effect of the purchase of glass. The loss of the window was a long term hit to the well being of the community.

Taking resources from their most productive use to a less productive use is not good economic policy, even though the borrowing of funds deployed results in a stimulative effect. The loan eventually must be paid back. By confiscating productive resources and spending them immediately, the government will stimulate the economy but the long term loss in productivity will never be recovered.

I lifted the following Hazlitt quote from a website biography:

"The art of economics consists of looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

As always, I thank you for your response. You and I actually have many common beliefs. We probably agree on 85 to 90% of all the issues. It is fun to discover where we disagree and to try to win the other over.

On Tue, Nov 4, 2008 at 4:44 PM, Al wrote:

Jack, I saw an interesting fact on CNN today. During the first year of a new president the economic growth rate averaged 4% for a Republican and 6% for a Democrat. Sounds like a winning ticket either way.