Interesting Times

I’ve long been fond of the reputed Chinese curse: ”May you live in interesting times”. Do the past few weeks qualify as “interesting times”? You betcha, by golly!

Having played the stock market for the past 40 years I am familiar with its vagaries, going both up and down and not always rationally. I must admit that the past couple of weeks have been rather exceptional. I did suffer through the dot.com bust, but made a bundle in the two or three years that followed. Will I be able to repeat? To coin a phrase, only time will tell!

All of this financial carnage plays out in the midst of a presidential campaign that marks, for better or ill, a change in personnel, if not of tone, at the top. Having watched the debates I am struck how no one really seems to come to grips with the various serious issues that confront us. We watch the candidates emote sound bites, criticisms – rarely accurate factually – and expound slogans and platitudes. None has spelled out in great detail the consequences of their proposals. Who pays for the new spending programs, whether for more health care, tax cuts for the “middle class” or buying up bad mortgages? Obama’s “middle class” seems to be anyone whose income is below $250,000 annually, or almost everyone living in America. Taxing the rich and benefiting the “middle class” isn’t going to pay the bills. The top 5% of American income earners already pay over 60% of total income tax and the bottom 42% don’t pay any. That appears to me a system already skewed against the wealthy. How much farther can you go?

The irony in all this is that no president, however gifted, can do anything by just directing that it be done. Government action generally involves legislative action. Any number of good initiatives have run aground in the shoals of a deservedly maligned Congress replete with prima donnas and well entrenched special interests. The current body under the leadership of Reid and Pelosi has not covered itself in glory, nor accomplished much. Proposals to spend garner wide support. Proposals to cut spending engender outrage by any and all of the affected beneficiaries. Does our Navy need more billion dollar destroyers? The Navy doesn’t think so, but Congress will be damned if it lets a single shipyard suffer. There isn’t a government program going that doesn’t put money into somebody’s hands, and few beneficiaries have ever voluntarily given up their benefits.

The candidates were asked at the second debate: “What sacrifices should you ask the American people to make during this time of economic crisis”. Both waffled around the issue with very weak responses. The present economic crisis cannot be blamed just on the greed of “Wall Street”. Everyone was in on the act from Congressmen who pushed populist programs and ever more spending while evading corrective actions until too late to the great American consumer who bought and bought and saved little in the false belief that the “good times’ would never end.

What is very clear although perhaps not recognized by the political classes is that issues drive politics, not the other way around. John McCain was asked what he “didn’t know” and his reply was that he didn’t know what was coming: what crisis and where. His statement is quite true: the future rarely mimics the past. We live in a world of constant change, but we assume that whatever is, will be forever! A bad base for sound policies.

The US may be the single most important player on the economic and political world stage, but it is not alone. Power and influence can be found in several other centers and the US can no longer call the tune without adjusting to others’ agendas. We bought lots of cheap goods from China, benefiting us as consumers, but we paid for these goods by selling US treasury bonds to China. As China’s foreign currency reserves approach a trillion dollars it has the power to destroy the US economy by refusing to buy more bonds and dumping those it has. Such action would also destroy the Chinese economy, so we have a new version of “mutually assured destruction”.

So while our presidential candidates and others of the political class dance over the surface of the present crisis there remain a series of issues that must be addressed in the near term. Briefly, these include:

Foreign relations - we live in a dangerous and turbulent world. The candidates should realize that countries don’t have “friends or enemies” but interests. Multilateral institutions are far from unified and few countries share US interests as completely as we might like. So often defense of the national interest may well require a “go alone” strategy, but this surely requires a careful balancing of our real national interest and our actual capacity to act. Persuasion and diplomacy are useful but interminable delays in reaching decisions should not be tolerated.

Financial systems and markets - bank deregulation originated with President Clinton and by and large has worked. What hasn’t worked is the creation of new financial instruments that were poorly understood and unregulated. Also, a very easy monetary policy on the part of the Federal Reserve led to easy money and lots of borrowing. There was also a lack of understanding of just how closely linked world financial markets are. There are billions of dollars floating around the world and no one government nor multilateral institution has any real handle on how to motivate nor for that matter to control the flows. Attacking the demonstrated flaws in the system should not mean permanent government intervention, government ownership and direction of financial assets nor instituting a harsh regulatory regimen that inhibits the needed flow of capital as it seeks its optimum rate of return.

Government fiscal policy - McCain spoke of the need to reduce spending and even talked about a spending freeze for at least part of the government. He also challenged defense spending. Obama only talks about the need to invest in any number of initiatives while cutting taxes but seems to think this can be paid for by increasing taxes on the “rich”, the oil companies and by closing “loopholes”, a delusion I think. Balancing government expenditures and revenues is unlikely absent a near economic collapse. The country appears to live in an “entitlement” atmosphere. Every problem can be solved by throwing government money at it. No existing program can be cut, whether we’re taking about farm subsidies, subsidies of ethanol or extraordinarily expensive military hardware. Frugality and discipline have disappeared. Neither candidate nor the Congress would appear willing or able to impose either on the nation.

Health care - A prime example of the “entitlement” mentality. We demand the best of medical care for everyone and for everything but don’t really like paying for it. The present system is broken. The biggest problem in the present system and one McCain’s proposal attempts to address is that since 1947 health insurance in the US has largely been company sponsored. No job with a company with benefits means no benefits.

An alternative system where health insurance is based on the individual independently of employment could free consumers to pick and choose from competing plans and, very importantly, would allow portability. Change jobs? No problem, no effect on your health insurance. Companies would be freed of the expense of these often subsidized health programs with the money made available usable for higher wages, lower prices or more investment. The proposed mechanism is to make health insurance expenses tax deductible for individuals and families, up to a limit, while removing the tax deduction feature from company plans. This is a wrenching change from current practice and worrisome to those who favor the “Nanny” state and prefer that Government set the standards and control the program.

Entitlement programs - Here we’re talking Social Security, Medicare, Medicaid and numerous other programs where tax money (or government borrowing ) is transferred for some form of welfare benefit. George Bush offered a program of partial privatization a couple of years ago. It went down in flames as no politician wants to offend the “greedy geezers” whose numbers and votes grow yearly. American youth are largely convinced that there will be no Social Security System in place when they grow old. Spending on these entitlements must be controlled to preserve public funds for other, necessary uses. There are four methods available: raise age eligibility to accord with increased longevity, raise taxes – already a regressive drag on young workers, reduce benefits like cutting back on cost of living increases, or impose a means test that denies benefits to the affluent. Privatization of retirement programs has been successful in other countries, but again the “Nanny “ state stalwarts oppose: people are too stupid to manage their own financial affairs, the governing elite must do it for them. As to the four possible adjustments, I know of no politician, presidential candidate, or not, who has proposed any one of them.

Energy - The country uses a lot of it and it shouldn’t. Aside from environmental impact, it makes excellent economic sense to reduce the relative cost of energy within the economy. Progress has been made: energy usage per unit of GDP has declined since 1973. The real problem as mentioned by both candidates is the $700 billion import bill for petroleum, much of which went to people who don’t have our best interests at heart. Parenthetically, neither candidate mentioned that the number one source of petroleum for the US is Canada and that Mexico ranked third. One technique already in place is to reduce demand and increase the relative value of the dollar. We now have oil at $90 a barrel instead of $140 so the import bill at least in the short run will be much lower even if we do nothing. Logic suggests we need to increase the supply of energy, preferably from domestic sources. Logic doesn’t necessarily lead to effective policy and economic reality proves a barrier. Few alternative sources of energy match the economic efficiency of burning petroleum. Spending millions on ethanol both in subsidies and an artificially high import tariff does far more for corn farmers, corn processors and farm interests than it does to alleviate the energy crisis. When you add in the impact on food prices of higher priced corn and the impact on the environment of more land plowed for corn production, it appears that we need to rethink the whole program and thrust in another direction. Expanded use of natural gas is one area. Offshore drilling is another. Expanded investment in nuclear energy is one more. Investment in wind, solar, tidal and geothermal sources are of interest especially if further research and development can bring unit costs down. Energy conservation is also important, a process that can be promoted by economic incentives like high gasoline taxes as used in Europe or some form of carbon tax. Neither candidate nor few members of Congress are likely to call for any form of tax increase: government mandated standards are the preferred route.

Environment - Overcoming environmental damage from whatever source and attempting to restore what has been lost is laudable, extremely difficult and closely tied to the whole argument on global warming. Sarah Pallin admitted that global warming was taking place and that we needed to adapt to that reality, but that its cause was not clearly known even though human actions undoubtedly played a role. She was right: Joe Biden’s statement that global warming is solely the result of human action was flat out wrong. Al Gore’s proposal that we can overcome the problem in ten years is delusional.

Climate conditions are very tricky. Eleven hundred years ago the world was so warm that the Norsemen thought Greenland suitable for raising barley and herding sheep. Five hundred years ago it was so cold that the grain crops in Europe failed to ripen and thousands starved. Sun spot variance, changes in the earth’s orbit, volcanic activity, burning fossil fuels that generate carbon dioxide? Or all of the above. No one truly knows and those who spell out just how many degrees the earth will warm in the next twenty years should lend their talent to our local weathermen who fail to forecast the weather accurately three days in advance. There are a lot of variables, but what is certain is that the combustion of fossil fuels is the cornerstone of the modern economy world wide and you can’t change this condition without horrendous restructuring of the physical economy and quite likely severe negative economic consequences. For example, Norway imposed very strict regulations to reduce carbon dioxide emissions including very high gasoline taxes. Per capita emission of carbon dioxide has been reduced, but the total tonnage produced by the country has increased. Why? More people, more cars and more oil wells.

Before leaving the environmental issue, an even more important element is the use – and misuse – of water. We have problems but the developing world, e.g. China and India , have far more severe ones. Shortages of potable water, pollution of what exists and increasing needs for industry and agriculture exacerbate the problem. Someone needs to address the US problem of the southwestern desert and population growth, the appropriate use of relative dry plains areas east of the Rockies and the contamination of our waterways. Straightening out rivers and putting dams everywhere have also been unhelpful in avoiding environmental damage. Do we really need cities in the desert or others below sea level and in flood plains?

Issues that need to be addressed or they will control our lives in ways not to our liking!