05 Nov 2010 Confidence Born of Predictability

It has been a busy week across the country, but especially, in Washington D.C. and on Wall Street. Republicans gained over 60 seats in the House, roughly twice the post-World War II midterm average. Ben Bernanke and the Federal Reserve risked credibility again by increasing their record stimulus to buy an additional $600 billion of Treasuries through June to reduce unemployment and avert deflation. And amidst it all the S&P 500 charged to its highest level since September 2008 on strong earnings releases and speculation that the Fed will indeed stimulate growth and that banks will be allowed to raise dividends. But alas, as the presumptive Speaker of the House John Boehner said on Tuesday night, “we have real work to do – and this is not a time for celebration.” 

Folks across America know all too well the economy is sick. They don’t need economic data or politicians to tell them so. Business owners and managers alike know all too well that the economy is well below its potential. Even while CEO’s report excellent earnings they wonder how much longer they can squeeze profits from cost savings. Ben Bernanke and the folks at the Fed are losing sleep over the possibility the country could slip into a deflationary cycle not unlike that of Japan. But as we have witnessed in Japan, merely throwing money at an economy where frugality born of years of uncertainty and doubt, will not fix the problem. No the simple recipe for success is confidence born of predictability.

What voters, consumers, small businesses, managers, workers, investors, and savers demand is predictability. Washington, if you truly are listening to the people, understand that what Americans really want is not change for change sake, but the kind of predictability that allows them to be able to build a future for themselves, their families, and neighbors. Stop changing the tax code with every new bill. Stop giving more entitlements to those “in the wagon” than incentives to those “pulling the wagon” as Senator Phil Graham says. Stop spending more than you take from us, and by the way, take less from us. Read the bills you sign. And bring confidence and predictability back by DOING what you SAY you will do and LEAD our government back to our Constitution.

We need only look at Japan to see the dangers that lie ahead for this country. Deflation there exists, not because the government hasn’t tried to end it, but because there is no confidence among Japanese. As William Pesek of Bloomberg points out “companies don’t trust that growth will return and so they avoid investing and hiring and trim salaries. Households fret about the future.” He says that “it’s telling that the hottest company in Japan is a bargain clothier. . . That’s quite a comedown for a nation famed for the Walkman and other world-changing technologies. Its headline-grabbing exports these days are bargain-price T-shirts and underwear made in China.” In case you missed it, Japan is no longer the world’s second largest economy as the country was surpassed by China in the second quarter of this year.

Our own history provides at least two powerful periods where confidence was at dangerous lows along with lessons for remedy for our government. In the years following the Great Depression the government pumped millions (GDP was $103 billion) into the economy, both fiscally and monetarily to get the engine going. It took 12 years for our economy to regain its pre-Depression size of $103 billion, but during that time our government almost doubled in size from $9.4 billion to $15 billion. Not until WW II demanded everything from industry, workers, and savers alike did the US economy reach a cycle of growth that was unparalleled in world history. One could easily argue that the most powerful catalyst was a kind of confidence inspired by strong leadership that the American way of life would not be conquered if we as a people (an economy) came together for the common purpose of survival. It was another kind of confidence that motivated corporate boardrooms; that of a predictable flow of dollars, billions of them being spent by our government toward the defeat of Imperial Japan and Nazi Germany.

In the 70’s we experienced a dearth of confidence similar to that of the Great Depression, but prices moved dramatically in the opposite direction. Inflation reigned during this period topping out at 13.5% in 1980. The Fed under Burns was printing money to beat the band while our government grew by 126%. In comparison GDP grew by only 74% and confidence remained dangerously low for a free-enterprise economy.

Then an actor from California rode into Washington DC with two radical ideas: cut the size of government and reduce taxes. During his first term President Regan, with a narrow majority in the Senate and a democratically controlled House was able to cut the top tax bracket from 70% to 50% and then to 28% in his second. During his first term GDP grew by 41% while he held the growth of government to only 27%. He managed these feats with only a narrow Senate majority in his first two years and against democratically controlled House and Senate his second two.

It could be argued that during his next term he just grew weary of fighting the will of Big Government Congress. He lost his majority in both houses for the last two years of his presidency as well as the reins on government growth. Government growth again outpaced GDP growth.

In this writer’s opinion, Mr. Regan’s greatest legacy was giving America back her confidence. He brought sanity back to the governmental process and with it a sense of predictability in the tax code, regulations, entitlements and the lot. He worked with big spenders like Tip O’Neal and Dan Rostenkowski eventually showing their big spending to be the cause of our country’s woes, not the solution.

Tuesday night, Mr. Boehner said “make no mistake, the president will find in our new majority the voice of the American people as they’ve expressed it tonight: standing on principle, checking Washington’s power, and leading the drive for a smaller, less costly, and more accountable government here in Washington DC.” We hope that he, as well as Mr. Reid and Mr. Obama will work together in a way that inspires confidence through predictability.

Americans are growing weary of “peaceful revolutions.” During the last decade we have swung from party to party with nothing but more government, taxes, and spending and less confidence. If confidence does not come back and soon, revolutions may be less peaceful.

Back in February an opinion piece appeared in the Wall Street Journal, authored by economic heavyweights George P. Shultz, Michael J. Boskin, John F. Cogan, Allan Meltzer, and John B. Taylor co-authored a piece that laid out the Principles of Economic Revival. They claim “our prosperity has faded because policies have moved away from those that have proven to work.”

According to them our economic crisis and anemic recovery are largely the result of “economic policies that have deviated from proven fact-based principles. … The most fundamental starting point is that people respond to incentives and disincentives (predictability). Tax rates are a great example because the data are so clear and the results so powerful. A wealth of evidence shows that high tax rates reduce work effort, retard investment and lower productivity growth. Raise taxes and living standards stagnate.”

The authors listed some points to guide policy makers toward remedy. They are as follows:

• Take tax increases off the table.
• Balance the federal budget by reducing spending.
• Modify Social Security and health-care entitlements to reduce their explosive future growth.
• Enact a moratorium on all new regulations for the next three years, with an exception for national security and public safety.
• Monetary policy should be less discretionary and more rule-like.

As you shake your head saying elected officials, new or career, will never work together to accomplish these changes. Perhaps the changes will not occur in the next two, four or six years, but they are possible. We have had a much more predictable tax code for long periods in our history. A simpler more predictable tax code may well become part of the 2012 presidential debate.

The federal budget CAN be balanced. It has been balanced before and yes by Democratic presidents. However, it cannot be balanced by promising a world of entitlements. Everyone will have to sacrifice. If you’ve ever pulled a wagon you know that as pullers hop on the wagon, the wagon’s weight eventually surpasses the strength the pullers. At that point, the wagon abruptly reverses course and rolls down the hill out of control until it spills all those aboard.

Modifying social security and healthcare entitlements will require sacrifice on the part of everyone. But they must be fixed. Ignoring the problem will not make it go away. People can work longer because they will live longer. Healthcare must be made more competitive. Every US industry of worth is in a fully competitive environment.

A big piece missing from the points above is one that I think is vital to the American recovery. We must restore American industry. The government can play a significant role by incenting new investment in manufacturing and mining and drilling through tax credits and even protection to a degree. While we allow China to float their currency with the dollar we essentially transfer the energy of our economy to the growth of theirs. Enough is enough. We should make it clear to the world and to China in particular that the US will absolutely protect its industry from government predatory pricing. Competition between industries must remain, but not between governments. Washington should immediately remove any and all tax and regulatory incentives for businesses to move jobs overseas and republicans should eagerly embrace the idea of bringing back American industry, even if it means using punitive trade measures.

It is going to take a sea change to restore confidence in the American economy. We hope for great things in the coming years as the American voter has again spoken loudly, but we understand the realities as well. Mr. President, Mr. Reid, and Mr. Boehner, now is the time.