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Out of the frying pan and into the fire?



October 28, 2008 – Comments (9)


Regardless of what you think about the Laffer Curve (the supply-side economic theory that lower rates actually generate higher government tax revenue because they encourage investment and provide an incentive to work hard), Art Laffer makes two very valid points in his recent WSJ Op-Ed piece.

The Age of Prosperity Is Over

The first point is about the lack of accountability and the moral hazard that a lot of the recent government intervention has caused.  I could not agree more with Laffer when he says "Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses."

Part of me fears that the lack of accountability for those who caused the problems will make it significantly more likely that we will find ourselves in a similar situation again in the future.  Also, part of me just wants pure revenge upon the scumbags like Angelo Mozilo or the former heads of Fannie and Freddie and morons like Chris Cox and Phil Gramm.  Anyone who played a part in creating the current financial crisis should lose their job and have any money that they made while this mess was created taken away.  Will this happen?  Of course not.

The second point from the article that I completely agree with is that we are going to see huge unintended consequences as a result of such massive government intervention.  Here's what Laffer has to say on the subject:

"But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

Some 14 months ago, the projected deficit for the 2008 fiscal year was about 0.6% of GDP. With the $170 billion stimulus package last March, the add-ons to housing and agriculture bills, and the slowdown in tax receipts, the deficit for 2008 actually came in at 3.2% of GDP, with the 2009 deficit projected at 3.8% of GDP. And this is just the beginning.

The net national debt in 2001 was at a 20-year low of about 35% of GDP, and today it stands at 50% of GDP. But this 50% number makes no allowance for anything resulting from the over $5.2 trillion guarantee of Fannie Mae and Freddie Mac assets, or the $700 billion Troubled Assets Relief Program (TARP). Nor does the 50% number include any of the asset swaps done by the Federal Reserve when they bailed out Bear Stearns, AIG and others.

But the government isn't finished. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid -- and yes, even Fed Chairman Ben Bernanke -- are preparing for a new $300 billion stimulus package in the next Congress. Each of these actions separately increases the tax burden on the economy and does nothing to encourage economic growth. Giving more money to people when they fail and taking more money away from people when they work doesn't increase work. And the stock market knows it."

Laffer goes on to talk about how almost every quickly implemented government knee-jerk reaction in the past has had terrible consequences, mentioning things from Nixon's wage and price controls, end of the gold standard, import surcharges to Carter's wellhead price controls, excess profits taxes on oil companies, and gasoline price controls at the pump.

Now I certainly don't agree with everything that Laffer has to say, especially his praise for Alan Greenspan.  Also, as much as I would like it if tax cuts really raised government revenue...I highly doubt that they do.  I don't necessarily agree that "The Age of Prosperity is Over" either.

However, like him I suspect that we may be jumping out of the frying pan and into the fire with all of the government intervention.  What will the unintended consequences of the bailout?  It's tough to say at this point.  Hyperinflation?  The eventual collapse of the U.S. dollar?  No one knows for certain.  What I do know is that if the government can screw something up, it usually will...and with the amount of money being thrown around here this time the screw up is going to be big.

I still think that a lot of money can be made in the stock market over the next several years, the key will be to figure out what the intended consequences of this government intervention are and how to profit from them.


9 Comments – Post Your Own

#1) On October 28, 2008 at 3:35 PM, Tastylunch (28.65) wrote:

Agreed. I love the transformers comic at the end.

I tell you Deej, I feel like there is a n immense amount of liquidity building up behind the dam of the banker's unwilingness to lend. Once they do lend again, that dam could break catastrophically flooding all of us in money supply. This is getting really really dangerous.

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#2) On October 28, 2008 at 4:08 PM, kdakota630 (29.09) wrote:

Excellent points, and LOVE that Transformers comic.

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#3) On October 28, 2008 at 4:52 PM, anchak (99.91) wrote:

Excellent post.....

And I echo ( and I think have said almost those exact words in a lot of blogs) what Tasty said!

My feeling is ...its extremely important to watch big banks earnings - like JPM,WFC and possibly BAC. The quarter they post QonQ and YoY earnings increase - that would be the time to drop everything and pile up on hard assets ( Oil & Gold) - because world would be awash in dollars.


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#4) On October 28, 2008 at 5:56 PM, lquadland10 (< 20) wrote:

And as we pay off our own personal debt save for a years worth of expenses and live below out means then it will get so much for the financial system.  May be they can go to some other country and bamboozle them into living on credit.

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#5) On October 28, 2008 at 9:40 PM, dexion10 (27.04) wrote:

Deej - great post.

I'd love it if you could respond with thoughts on a couple things I've had on my mind.


1. Are we U.S. tax payers being a bit dishonest with themselves regarding how much of the gov't liabilities we're paying for?

For example we complain about how much the Iraq war cost or how much the wall street bailout's cost but the last time I checked our current account deficit is being funded by foreign countries like China and Saudi Arabia....  Every year the U.S. debt grows - precisely because the tax payer isn't paying for the benefits he/she receives.

So are we being a bit too incredulous - if I was a foreign lender I'd be more bent I think.... these guys can't run deficits like the USA... look at Iceland, Hungary, and Russia... they can't sustain deficits.... the double standard is unconcionable isn't it?


2. Do you believe that supply side economics has just had a watershed moment and failed?


It seems that while low interest rates incentivize investing they don't necessarily benefit the economy if the quality of investments people make are degraded.

Would you agree that the low interest rates caused inflation expectations so savers and saving nations felt compelled to "INVEST" and the best yielding investments going were CDO's and hard assets like oil and copper.

Seems like too much of a good thing can ruin the economy... but of course I am a New Keynesian at heart.

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#6) On October 28, 2008 at 10:55 PM, abitare (30.07) wrote:

Good Post Art Laffer is a BS artist. Peter Schiff made him look like a complete idiot.

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#7) On October 28, 2008 at 11:53 PM, awallejr (28.75) wrote:

I don't know what world Art Laffer lives in, wish I was debating Schiff instead tho.  Schiff is absolutely wrong about most mortgages readjusting over 50% in years ahead.  I am a real estate attorney by profession.  The bad loans are now in default as it is.  People on the teasers have for the most part already started walking away.

He also ignores the fact that the American worker has actually become MORE productive.  Cracks me up that he says women don't want to work and just stay home heheh.  I know quite a few woman that want to work just to get away from their husbands lol.


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#8) On October 29, 2008 at 1:55 AM, GCrackers101 (< 20) wrote:

Laffer and his supply side economics was discredited during the Reagan years.  I should take his thoughts with a grain of salt.

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#9) On October 29, 2008 at 10:15 AM, TMFDeej (97.62) wrote:

Thanks for the comments everyone.

I am really not that big a Schiff fan, though I did recently purchase his new "Little Book" and I will eventually read what he has to say.  It's probably a blank 200 pages followed "BUY GOLD" in huge print on the last page, but I threw him a few scheckles any how.

lquadland10.  It is true that right now the U.S. is spending much more money than it is taking in in tax revenue, but I don't see how this can possibly continue least not at the rate that it has been.  The countries who are buying our paper are eventually going to want their money back. 

I think that you hit the nail on the head when you said that the double standard of the U.S. being able to continually print money and other countries just lapping it up like doge is unconcionable.  Eventually the U.S. will have to begin to whittle down this debt or people will stop lending to least at the low interest rates that we have been giving them. 

I doubt very much that the government will show much in the way of fiscal restraint.  To me, this means that we will likely see higher interest rates and a less valueable U.S. dollar at some point in the future.

Unfortunately, I believe that supply side economics is probably a bunch of garbage.  I may pretend to continue to believe in it because I love the idea of lower taxes and low interest rates though ;).

Investors' appetite for risk was way too huge over the past decade.  Risk premiums for everything from junk bonds, to arbitrage, to CDOs etc... were way too low.  In some respect I think that the increasing rates of return that investors are now demanding for these things is healthy.  Of course, cheap money fueled the boom and more expensive money will slow things down.


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