Tuesday, December 23, 2008

The Cost of Going Green

Driving around Stanford and the neighboring upscale suburbs brings to mind the 1978 film, “Invasion of the Body Snatchers,” in which alien pods replaced earthlings as they slept. As we sleep, Hybrid Priuses are gradually replacing every other make and model of car, including Volvos, the long, venerated, automotive symbol of socialist Sweden. A Prius, which gets over 45 miles per gallon, is the ultimate green symbol.

What’s the cost of going green?

A comparison between two different Toyota models, the Prius and the non-hybrid but otherwise somewhat comparable Corolla, reveals the cost. The basic 2009 Corolla can be purchased for $16,150 plus sales tax; in California, that brings the price to about $17,525. The stripped-down Prius sells for about $22,000; with tax, $23,870. The difference in the initial purchase price is $6,345.

The web site, automotive.com, presents data on the cost of ownership over a five-year period. For the 2008 models, the estimated costs of ownership, which include depreciation, financing, insurance, repair, state fees, maintenance, and fuel, amount to $23,372 for the Corolla, and $24,083 for the Prius. The comparison presumes mileage of 15,000 per year. Prius does better on fuel: $368 in savings with gasoline at $2 a gallon; $552 at $3/gallon; and $736 at $4/gallon. The savings rise as miles driven and the price of gasoline increases. But the Corolla is less costly for all other elements of ownership.

The data on used car prices fluctuate wildly, depending on mileage and condition. An internet search of 2001 Priuses reveals prices ranging between $8,000-12,000, with comparable Corollas ranging between $6,000-9,000. Using a rough average, Prius owners recover about $2,500 more than Corolla owners in resale value.

All in all, the cost of going green is on the order of $1,000 a year. But these numbers apply during normal times.

In December 2008, with a glut of cars in dealers’ lots, a 2009 Corolla is available for about $14,000, while a similarly discounted Prius, available only for the top-of-the-line model, goes for about $24,500. The puts the annual cost of going green at about $1,200. An extra $100 or so a month is small change to the average affluent resident of the mid-peninsula Bay Area.

Merry Christmas (and/or Happy Chanukah) to all, and if you want to keep your current car, be sure to leave the garage lights on all night!

Thursday, December 18, 2008

Protecting Which Taxpayers?

Members of Congress, the White House, and the Treasury have been repeating the mantra of “protecting taxpayers” in the use of “bailout” funds, the $700 billion TARP (Troubled Assets Relief Program) enacted by Congress. The phrase implies that the government wants this money to be repaid to the Treasury, thereby preventing taxpayers from having to make up any losses.

First things first. Excluding TARP and Obama’s projected fiscal stimulus, the federal government’s budget deficit was estimated in the neighborhood of $500 billion for fiscal year 2009 (October 1, 2008-September 30, 2009). TARP is being financed by federal borrowing, not increased taxes. Obama’s stimulus plan could add another $800 billion or so to federal spending over the next two years, which will also be financed by borrowing.

Assume some or all of the bailout funds are recovered by the Treasury. Any such funds are likely to be appropriated by Congress to spend on government programs rather than redeem the borrowed funds and reduce public debt.

As to “protecting taxpayers,” who is at risk?

If it becomes necessary to raise taxes, Congress could raise income tax rates across-the-board or only on upper-income households. The distribution of income taxes in 2006, the latest year for which data are available, is as follows: the top 1% of households ranked by adjusted gross income paid 40% of total income taxes in fiscal year 2006, the top 5% paid 60%, the top 10% paid 71%, the top 25% paid 86%, and the top 50% paid 97%. Whichever approach is taken, higher-income households will pay the bulk of the increase. But this is the group on which Obama and the Democrat Congress want to increase tax rates. For these households, “protecting taxpayers” is empty rhetoric.

Ironically, the true losers could be lower- and lower-middle income households. The Treasury, the Fed, and Congress are trying to head off the potentially harmful effects of deflation and return the economy to growth. However, the creation and circulation of so much new money could fuel inflation in the next few years, which generally hurts lower-income households more than the wealthy. Should this occur, Obama will have a hard time explaining himself to the electorate in the 2010 Congressional and 2012 general elections.


Tuesday, December 16, 2008

Preventing Another Financial Crisis

Several scholars and journalists have recently criticized the application of mathematical models and high-powered econometrics to the purchase and sale of securities. In an article titled “Wall Street Lays Another Egg” in the December 2008 issue of Vanity Fair, distinguished financial historian Niall Ferguson has written an informative account of the current financial crisis. His central theme is that mathematical models ignore both history and human nature. A particularly poignant phrase, with apologies to Euripides, reads “those whom the gods want to destroy they first teach math.”

Mathematics is extremely useful in many fields of endeavor, but perhaps it has been pushed beyond its applicability in the worlds of academics and finance. To balance the belief that above-average returns require higher risk, for which mathematical models play a crucial role, perhaps all business school students, especially those who specialize in finance, should be required to read and reflect upon Aesop’s fable of the Hare and the Tortoise.

A hare one day ridiculed the short feet and slow pace of the Tortoise, who replied, laughing: "Though you be swift as the wind, I will beat you in a race." The Hare, believing her assertion to be simply impossible, assented to the proposal; and they agreed that the Fox should choose the course and fix the goal. On the day appointed for the race the two started together. The Tortoise never for a moment stopped, but went on with a slow but steady pace straight to the end of the course. The Hare, lying down by the wayside, fell fast asleep. At last waking up, and moving as fast as he could, he saw the Tortoise had reached the goal, and was comfortably dozing after her fatigue.

The Moral: Slow but steady wins the race.

Monday, December 8, 2008

Putting Job Losses in Perspective

The U.S. economy lost 1.9 million jobs in the first 11 months of 2008, with December losses expected to push the total above 2 million. The November loss of 533,000 jobs is the highest number since December 1974. The unemployment rate rose to 6.7% and could pass 8% before the downturn is reversed.

To put these numbers in perspective, consider the case of China. As the country upgrades from low-value added agriculture to higher-value added industrial and service sector output, its economy created more than 80 million jobs between 1994 and 2004. In the four years 1998-2002, the economy successfully absorbed 3 million laid-off workers from money-losing, restructured, state-owned enterprises.

During the more recent period 2003-7, the economy created 51 million new jobs, the equivalent of a new city of 10 million workers every year. During these five years, 24.8 million laid-off workers were re-employed in new enterprises.

In March 2008, well before the financial crisis erupted, China’s goal was to generate 15 million jobs a year by 2020, raising the number of urban and town residents from 280 million to 510 million.

The global slowdown has complicated this goal. Numerous low-margin factories in south China have closed down, with employees returning to their rural homes. Tens of thousands of new graduates from an increasingly educated population will find it harder to secure employment. Indeed, China’s leadership has announced that it will return to 10% growth in 2009 from an estimated 7.5% this year. The difference is millions of jobs.

As the policy-makers in Washington D.C. struggle to reverse the current economic decline, imagine what it must be like in the inner circle of China’s counterparts.

Friday, December 5, 2008

Consolidation is Just a First Step

Some politicians are calling for a consolidation of the Big-3 U.S. auto companies. Perhaps a merger between GM and Chrysler. Maybe later, a merger with Ford, producing one, hopefully viable, competitive, domestically-based automobile company.

Federal support for the financial sector has already resulted in several large mergers. Wells Fargo has taken over Washington Mutual and Bank of America has acquired Wachovia. Down the road, there are likely to be more mergers, shrinking the number of large banks.

Delta has merged with Northwest. United and American airlines are possible candidates for mergers with other domestic or foreign airlines.

National health insurance may be just an Obama administration away.

For good measure throw in federal financing of new homes.

How about more federal control over education?

Each a small step toward a “mixed” public-private partnership” economy; together a giant step toward central planning.

It can’t happen here! Think about it.

Monday, November 17, 2008

It’s Only a Matter of Zeros

In the mid-1990s I was conducting research on the operations of local stock exchanges in the Caribbean. Sitting in the office of an individual I was interviewing, he interrupted our conversation to place an order for U.S. government bonds.

The company for which he worked was an offshore pension fund of a major multinational energy firm with headquarters in the United States. The reason for the funds location in a Caribbean jurisdiction was the absence of a corporate income tax, which enabled the fund to earn a pre-tax return on its investments until money was repatriated as required to pay the pensions of the firm’s retirees.

Returning to his phone call, he placed an order for $150 million of U.S. government bonds. My jaw dropped. I was not then used to hearing instructions to purchase financial assets in such large amounts. Looking at my discomfiture, he casually remarked “It’s only a matter of zeros.”

Fast forward to late 2008. Millions are so small as to no longer constitute a rounding error on government expenditures, tax cuts, or the creation of credit by the Federal Reserve Board. The same applies to most of Western Europe. The U.S. federal budget deficit in fiscal 2009-10 could well amount to $1 trillion ($1,000,000,000,000). The Congressionally-enacted TARP program authorized $700 billion ($700,000,000,000) for the purpose of preventing an implosion in U.S. financial markets. Additional appropriation of funds if needed could propel that above $1 trillion ($1,000,000,000,000). The Fed’s increase in credit since the financial crisis unfolded is estimated at $2 trillion ($2,000,000,000,000). The federal government’s public debt has surpassed $10 trillion ($10,000,000,000,000) and will grow rapidly during the next few years.

Will these subsidies, loans, credits, and deficits be repaid? Perhaps, but not in the short run. Perhaps only indirectly through inflation. As I noted in a previous post (March 6, 2008), the time may soon come for the fresh printing and circulation of $500 and $1000 bank notes, as the existing $100, $50, and $20 notes come to buy less.

Tuesday, November 11, 2008

Saving Detroit’s Big Three

Labor unions played an important role in helping get out the vote for President-elect Obama, and expect a payback for their efforts. In addition to the $25 billion appropriated by Congress for retooling by General Motors, Ford, and Chrysler, the big three are seeking another $50 billion lest they run out of cash in 2009 and declare bankruptcy. If President Bush refuses to go along with Congressional support for additional aid, it is almost certain that the new Obama administration will place such financial assistance at the top of its agenda.

Additional federal funds for the automakers is principally directed at keeping their employees on the job and sustaining the benefits that labor unions have extracted for their members. However, Obama will need to make clear that both auto executives and assembly-line employees will have to accept harsh measures to keep from facing the same problem in the next year or two. Unless Obama makes explicit that the additional $50 billion might be the last tranche of aid, the unions are likely to hold out for higher wages and benefits, instead of accepting the necessary reductions in jobs and compensation to make the automakers competitive with imports and domestically-produced foreign brands.

It’s hard to imagine the United States of America without General Motors, Ford, and Chrysler. But then again, the current financial crisis is a once-in-a-century event, and many long-standing, reputable financial houses are no more.

Monday, November 10, 2008

Sales Tax Hike in California

To close the state of California’s large budget deficit, Governor Arnold Schwarzenegger has proposed a combination of spending cuts and a (temporary) increase in the sales tax of 1.5 cents. Without new tax revenue, the state cannot meet its proposed budgetary expenditures.

This situation raises the question that few public officials are willing to confront. How can the people meet their budgetary commitments if the state takes more money from their pockets? Homes are being foreclosed, wages and benefits are being frozen or reduced, workers are being laid off or having their hours reduced, medical and food costs are rising, yet the governor’s solution of higher taxes would put even greater stress on strapped household budgets.

Before we ask how the state and local governments can get by with less money, we first need to ask how the people can get by with less money.

Thursday, November 6, 2008

Fixing Social Security—An Obama Priority

President-elect Obama has proposed to fix Social Security by transforming it from a partial contribution-linked, old-age benefit program into a more explicit tax-and-transfer regime. The transformation will further shatter the myth that payroll taxes represent an individual’s contribution to his old-age government pension by further breaking the link between contributions (payroll taxes) and benefits. The transformation will be done in a few short steps.

First, Obama has proposed to create a “Making Work Pay” tax credit, the principle source of giving middle-class Americans a tax cut. Workers will be provided with a refundable tax credit equal to their share of the Social Security payroll tax (6.2 percent of payroll) on the first $8,100 of earnings. Those earning up to $8,100 would receive $500 each or $1,000 per family. The credit would be completely refundable against personal income tax, offsetting that amount in income tax liabilities, but would likely be phased out for high income earners. Refundable also means that individuals or families would receive a government check for $500 or $1,000 even if they have do not owe any income tax. The refunds would ostensibly come from general revenue, but that is a mere accounting notion, as the money has to be borrowed in any case.

Second, currently projected to start in 2018 or later, Obama would impose additional Social Security tax on persons earning more than $250,000 a year, at an initial rate between 2 and 4 percent, split between employer and employee. He has yet to specify if the tax would apply to capital income (dividends, interest, capital gains) or whether those paying the tax would receive larger benefits (unlikely).

Once in place, the size of the refundable tax credit could be increased, the rate of additional tax on those making over $250,000 could be increased, and the $250,000 threshold could be lowered.

With these changes, the Social Security payroll tax would morph into a much more explicit income redistribution scheme. Nor would it take much effort to extend Obama’s transformation of Social Security to Medicare, and then combine the two.

Wednesday, November 5, 2008

Some for the Love of Ireland, More for Hatred of Peel

Sir Robert Peel held office as Conservative (Tory) prime minister of Great Britain during 1841-46. Seeking to foster economic growth in heavily protectionist Britain, he undertook two revisions of the tariff in 1842 and 1844-45 to free up trade. Although tariff revenue declined £192,000 and £204,473 respectively, the corresponding value of trade due to lower duties rose £410,000 and £835,760. Peel compensated for the lost revenue, in part, with an income tax of about 3 percent (7d./£) on annual incomes over £150. Despite lower tariffs, revenue actually increased on some goods due to the expansion in trade.

As a Tory, Peel came into office committed to the principle of agricultural protectionism. The long-standing Corn Laws restricted grain imports. However, the potato famine in Ireland forced him to open Irish ports to food imports in 1845, which represented an unplanned extension of his movement towards free trade.

To prevent future famines, in 1846 Peel proposed repeal of all grain duties to take effect on February 1, 1849. The measure passed both houses of Parliament by June 25, 1846, and received royal assent the following day. However, Peel was not to escape the wrath of the landed Tory interests. Famine was followed by disorder in Ireland, which compelled him to propose an Irish Coercion Bill for parliamentary approval. In this, Peel was defeated by a combination of Irish, Whigs, and Protectionist Tories, “some for the love of Ireland, more for hatred of Peel.” Peel served in opposition in Parliament until his death in 1850 by a fall from his horse.

John McCain was soundly defeated in his quest for the presidency, “some for the love of Obama, more for hatred of _____.” (Bush? Spendthrift Republicans? Other reasons?).


Monday, October 20, 2008

The Road to Socialism (Serfdom)

Arthur Schopenhauer is famous for many statements. My favorite is the process of establishing truth. “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”

Taking a page from Schopenhauer, the road to socialism in America passes through three stages. First, combine small banks and companies into large banks and companies. Second, have the government take shares in large banks and companies. Third, have the politicians direct the flow of capital, investment, production, employment, and consumption.

We are part way into stages one and two, under a Republican president and administration, no less. It won’t take long for stage three to emerge.

Wednesday, October 15, 2008

Now that we Own the Banks,...

We, the American taxpayers, are now part owner of America’s leading banks. So, when can we expect to receive dividends from our investment?

The answer is very soon, but in the form of new taxes, not a check or electronic deposit. After all, somebody has to pay for the extra hundreds of billions of dollars that are being deployed to save the financial system. When and if our shares, of which the Treasury is temporarily trustee, are sold, hopefully for a profit, it is likely that Congress will find it more constructive to spend the money on new or existing programs than return it to us. That’s what they do with surplus Social Security taxes.

The constant refrain that the government is looking out for the taxpayer in administering the $700 billion appropriated by Congress will, in all probability, turn out to be a will-o’-the-wisp.

Thursday, October 9, 2008

Saving vs. Consumption: The Age-Old Dilemma

Economists have long pointed to the lack of savings in the United States, which has contributed to the current financial crisis. The magnitude of U.S. debt is truly staggering: a $700 billion annual current account deficit, a $500 billion annual budget deficit (likely to reach a trillion dollars as the Treasury borrows money to implement the “rescue” package), private credit card debt, and so on. Roughly half of publicly-traded U.S. Government debt is held by foreigners. Foreigners also finance the current account deficit.

The result of too much spending and too little saving was aptly set forth in Chapter xii of David Copperfield, in which Charles Dickens spelled out the consequence of overspending:

“Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

Wall Street financiers and analysts nonetheless proclaim that recovery from the current downturn requires consumers to open their wallets and purses wider. This will presumably happen when consumers feel comfortable to borrow and incur more debt. So much for increasing savings.

Wednesday, October 8, 2008

Senator McCain: You Cannot be Serious!

With apologies to John McEnroe, Senator McCain’s proposed nationalization of a portion of the private mortgage market—purchasing up to $300 billion in mortgages directly from homeowners and replacing them with new, fixed-rate mortgages based on the lower value of their homes—extends the $700 billion “rescue” of financial institutions to a more expansive level of government involvement in the economy. Let’s call it for what it is, “A New New Deal.” Perhaps David Stockman was right when he said that “There are no real conservatives in Washington.”

During the second presidential debate of October 7, 2008, McCain offered little to nothing to conservatives. Running under the Republican party banner, he repeatedly promised to reach out to Democrats to enact the major proposals of his campaign.

What’s next from Senator McCain? How about more billions to buy shares of stock that constitute the S & P 500 to prop up the stock market? Billions for delinquent credit card accounts? A new TVA-style Government Energy and Reconstruction Company?

“Say it ain’t so, John. Say it ain’t so.”


Thursday, October 2, 2008

A New Era of Democratic Socialism has Begun in the United States

British Prime Minister Margaret Thatcher and President Ronald Reagan symbolized the end of socialism as a prominent economic philosophy. Its demise was reinforced in the collapse of the Soviet Empire, the emergence of market economies in Central and Eastern Europe, and the opening up of China’s economy under the leadership of Deng Xiaoping.

Reagan’s achievements were first undermined in 1991 by President George H. W. Bush when he approved an increase in the top marginal rate of income tax from 28 to 31 percent. Although President Bill Clinton added two higher rates of 36 and 39.6 percent, he agreed to welfare reform and limited increases in federal spending, resulting in record budget surpluses. Clinton himself proclaimed that the era of big government was over. Federal Reserve Board Chairman Alan Greenspan worried about the fed’s ability to conduct open market operations if the federal government redeemed all its debt.

The “compassionate conservatism” of President George W. Bush, coupled with record spending of a Republican Congress (2001-06), marked a return to the era of big government. The financial crisis of 2008 solidified the new era, socializing large chunks of the financial sector and who knows how much more to come. Assuming passage of the “financial rescue” bill by Congress, the projected deficit for fiscal year 2009 (October 1, 2008—September 30, 2009) might reach one trillion dollars.

What are those who espouse free markets and limited government in ostensibly conservative think tanks to do? Defending free markets in the light of massive government involvement to resolve the financial crisis that emerged under a Republican president and Congress does not appear promising in the foreseeable future.

The residue of genuine free-market analysts, along with a younger generation of similarly inclined scholars, will still have plenty to do, researching and recording the inevitable shortcomings and defects of the new American socialism. After a decade or two, free-market, limited government policies may once again look attractive.


Friday, September 26, 2008

The U.S. Financial Crisis: The China Connection

For many years, Treasury Secretary Henry Paulson, his predecessors at Treasury, and other prominent American academics and financiers lectured China on the need to reform its financial system and how to do it. China succeeded in fixing its banks, but not on the basis of the advice given by U.S. experts. Perhaps China’s successful recapitalization of its banking system provided Paulson with some valuable information on how to resolve the U.S. financial crisis.

China began to dismantle its central-plan economy in 1978 with agricultural reforms, followed by manufacturing. China’s 10 percent annual real growth since 1978 led to a massive increase in bank lending, resulting in many bad non-performing loans (NPLs). China forcefully addressed this problem. The goal was to enable the big four state-owned commercial banks—the Bank of China (BoC), China Construction Bank (CCB), the Industrial and Commercial Bank of China (ICBC), and the Agricultural Bank of China (ABC)—to sell stock and operate as public companies. This required cleaning up their balance sheets. As recently as the fourth quarter of 2003, NPLs in the four banks were estimated at 20 percent of total loans, with skeptics putting NPLs even higher.

The process of fixing China’s banks began in the midst of the Asian financial crisis in 1998. The Chinese government doubled the banks’ capital bases by giving them $32.5 billion through complex swap agreements, in which bad assets were exchanged for government bonds. In 2001 and 2002 China established four asset management companies that bought $169 billion worth of NPLs from the four banks at face value, thereby taking them off the banks’ balance sheets. Despite these measures, NPLs continued to erode the capital bases of the banks. In early January 2004 China transferred $45 billion from its foreign exchange reserves to BoC and CCB, equally split between them.

At the end of 2004, China announced plans to inject capital into ICBC and ABC to enable them to spin off NPLs and build a new corporate governance structure as publicly-listed companies. The government injected $15 billion into ICBC in April 2005. Three of the banks went public. CCB raised $8 billion in its IPO of October 21, 2005, BoC raised $9.7 billion in May 24, 2006, and ICBC raised $21.6 billion in the largest IPO in history on October 20, 2006. Some of the world’s biggest banks and financial institutions invested billions of dollars to acquire minority stakes in the three banks. ABC’s IPO will likely transpire in the next few years. Altogether, the Chinese government spent more than $400 billion to fix China’s banks.

As head of Goldman Sachs, Paulson frequently traveled to China to explore business opportunities. At Treasury he established a twice-yearly meeting with China known as the U.S.–China Strategic Economic Dialogue to discuss issues of mutual interest. Perhaps China’s success in transforming its decrepit banks into world-class financial institutions influenced Paulson’s design of the $700 billion package announced on September 19, 2008, to remove bad assets off the books of U.S. financial institutions.

The U.S. Financial Crisis: The Bush Connection

Among the villains in the U.S. financial crisis is President George W. Bush. There is near consensus among economists and global bankers that the principal source of the crisis is subprime mortgages, granted to individuals who could not otherwise afford to purchase a home. Foreclosures on these homes are heavily concentrated in California's central valley, Arizona, and Florida, home to large numbers of Hispanics.

On June 18, 2002, President Bush addressed the staff of the Department of Housing and Urban Development (HUD). Eighteen months into his first term, he raised the issue of the homeownership gap in the United States. Noting that three-quarters of Anglo-Americans (of European descent) owned their own homes, but less than half of African-Americans and Hispanics did so, he recommended that the federal government strive to create an additional one million minority homeowners by 2010.

Bush proposed such specific measures as lowering the down payment for first-time homebuyers, enacting a housing tax credit, simplifying mortgage and all other documents dealing with homeownership, and educating people on the legal implications and ramifications of buying a home.

He urged Fannie Mae and Freddie Mac, two government agencies that finance home loans (both taken over by the federal government in September 2008), to use their influence to create capital to help African-Americans and Hispanics purchase homes. He urged HUD to mount an active outreach program to identify potential minority home buyers.

Bush may have played only a small part in precipitating the financial crisis, but his remarks surely reinforced the political pressure on lenders to relax mortgage requirements on potential minority homebuyers.

Sunday, August 31, 2008

Addicted to Oil?

What does it mean to say that we are “addicted to oil?” That we should not pay $700 billion a year to import oil from foreign countries, especially those that oppose American interests. That we should not pollute the air and contribute to global warming? That we should live in densely populated urban centers instead of sprawling suburbs? That we should develop alternative sources of renewable energy? The notion of addiction implies, as it does for narcotics, that the consumption of oil is habit forming, that we are compulsively and physiologically dependent on it, even though it is an essential element in transportation, heating, and manufacturing.

The metaphor of addiction to oil applies equally to food, water, shelter, clothing, education, and medical care. Each is an important element of life. Why aren’t we badgered to reduce our addiction to them? Perhaps it has to do with the interests of those who would benefit economically and politically from substituting other sources of energy for our heavy consumption of oil. It is difficult to formulate a sensible national energy policy when our political language treats oil as if it were a narcotic instead of a vital economic resource.

Wednesday, August 27, 2008

Count Every Vote, But not Every Voter

The U.S. Census Bureau publishes estimates of voter registration and turnout in its Current Population Survey following each presidential and off-year Congressional election. For the presidential elections of 2004, 2000, and 1996, voters respectively constituted 63.8%, 59.5%, and 58.4% of the 18+ eligible citizen population. For the off-year elections of 2006, 2002, 1998, and 1994, voters respectively composed 47.8%, 46.1%, 45.3%, and 48.3% of the eligible citizenry.

The turnout trend line in the three previous presidential elections has been up, with a significant 4.3% increase in 2004 over 2000. A fair guess of turnout in 2008 may well exceed 65%.

A two-thirds turnout means that fully one-third of eligible voters will not be counted when the results are tabulated. If 65% vote and if the election is close, it means that just over a third of the eligible electorate will decide the outcome.

Beware of the next president claiming a mandate for his policies.

Tuesday, August 26, 2008

Two Roads Diverged in a Yellow Wood

“The Road Not Taken” by Robert Frost describes the two presidential campaigns. Senator Obama promises change, which means putting himself in the White House, not another Republican. Senator McCain promises to reach across the aisle to solve the country’s problems, which means accepting what Democrats want and declaring the problems solved.

“Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;”

Translation: It would be nice to know the outcome before starting

“Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same,”

Translation: Six of one; half a dozen of the other

And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.”

Translation: Neither path had been taken that morning

“I shall be telling this with a sigh
Somewhere ages and ages hence;
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.”

Translation: What? As both was equally worn and neither had been trampled in the early morning, there was no difference

Summing up: No difference. The election is largely about who fills the offices in the federal buildings in Washington.

Thursday, August 21, 2008

The Economic Consequences of a More Diverse America

On August 14, 2008, the U.S. Census Bureau released its projections for the ethnic composition of the population in 2050. The key finding is that minorities, which currently constitute one-third of the U.S. population, will rise to 54%. As early as 2023, minorities will comprise more than half of all children.

The breakdown in 2050 is projected as follows: non-Hispanic white alone: 46.3% (65.7% in 2008); Hispanic: 30.3% (15.4% in 2008); black: 14.0% (15.0% in 2008); Asian: 9.2% (5.1% in 2008); and mixed race: 3.7% (1.7% in 2008). American Indians, Alaskans, Hawaiians, and Pacific Islanders will increase by less than 1%. The two largest changes are a one-third decline in the non-Hispanic white and a doubling in the Hispanic population.

Numerous studies have attempted to determine high school and college graduation rates among Americans. A sampling includes the Center for Public Education, the U.S. Census Bureau, the Urban Institute Education Policy Center, and a National Bureau of Economic Research paper written by Chicago professor James J. Heckman and American Bar Association affiliated Paul A. LaFontaine. Although the numbers and percentages differ among the four reports, all found a large gap between Asians and Whites, the top two groups, and blacks and Hispanics, which enjoyed lower graduation rates. Depending on the methodology employed, the gap between whites and blacks/Hispanics ranged between 16-28 percentages points. The gap was a few percentage points greater between Asians and blacks/Hispanics. These gaps have persisted for 35 years. The gaps were even larger for college graduation rates.

Unless blacks and Hispanics markedly increase their secondary and tertiary graduation rates, the average educational level of the American work force will steadily decline in the coming decades as better educated whites are replaced by less well-educated blacks and Hispanics. On this trend, America will steadily lose competitiveness. America must find the means to better educate its minorities.

Tuesday, August 19, 2008

Obama’s Tax Proposals: Does He Really Mean it?

Obama advisers Jason Furman and Austan Goolsbee were in the news last week with some specifics of Senator Obama’s tax proposals, which are also posted on his web site. A great fear in Wall Street and among investors was that Obama would tax dividends and capital gains as ordinary income, up to 39.6% for upper-income families. To their relief, the top rate on dividends and capital gains will only rise to 20%, and apply to families with annual income over $250,000. Those with income below $250,000 will pay current rates. Obama will restore the 36%and 39.6% tax brackets that prevailed during the 1990s, but only on families making over $250,000 (individuals over $200,000). Obama’s estate tax would exempt $7 million per couple, and impose a 45% rate on the balance.

A second great fear is that Obama will impose a 12.4% surtax on Social Security payroll taxes on earned income exceeding $250,000. Under existing law, workers and employers together pay 12.4% on the first $102,000 of earned income. (Medicare payroll tax of 2.9% is not subject to an earnings cap.) Obama’s campaign remarks suggest a rate of 2-4% and that the surtax would not commence for ten years.

The additional revenue collected in these measures would be used to help fund tax credits for middle-class households, a zero capital gains rate for small business and start-ups, a permanent research and development credit, zero tax on seniors making less than $50,000, and several other measures. Obama also pledges to close loopholes and go after tax havens.

Two issues arise in Obama’s proposals. First is the taxation of interest income as ordinary income. Many economists attribute the large budget and trade deficits in the U.S. to its low savings rate. Wouldn’t it make sense to tax interest at the same lower rate as dividends and capital gains, thereby increasing the incentive to save?

The second issue is trustworthiness. If Obama is elected president, will he keep to the proposals articulated by Furman and Goolsbee and posted on his web site? Or, will he flip-flop to higher tax rates? This is the $64,000 question.

Friday, August 8, 2008

Where Have All the Oil Speculators Gone?

As posted oil prices soared from $85 a barrel on February 1, 2008, to peak at $142 a barrel in early July, several Congressional committees held hearings to investigate the role of speculators in pushing up prices. Members of Congress went after oil company executives with hammer and tongs, proposing windfall profits taxes on oil company earnings and new restrictions on traders. Congress adjourned on August 1 until after Labor Day before it enacted any new measures.

Good thing, too.

Imagine another round of Congressional hearings, this time with oil company executives and traders on the dais where Members of Congress usually sit and members in the chairs below facing tough questioning. How would members explain the fall in prices to $115.60 a barrel for NYMEX crude futures by August 8? How would they explain why greedy oil companies would willingly give up $30 a barrel in earnings in the short period of a month? Where did the speculators who profit by pushing up oil prices go?

"I have a dream." That someday Members of Congress will face the same judgment as business executives and traders.

Thursday, August 7, 2008

Karl Rove—Mandrake the Magician or Reverse King Midas?

Since leaving the White House in August 2007, Karl Rove has become a political pundit on Fox News and a regular contributor to the Wall Street Journal. His modus operandi is to offer advice on what political candidates should do to win, with special attention given to Senator John McCain.

Rove is often credited with masterminding President Bush’s two electoral victories. But consider the state of the Republican Party in August 2007 following the November 2006 elections.

The Republican Party has gone from being the majority party to the minority in both Houses of Congress. Democrats gained 31 additional seats in the House and 5 in the Senate. They secured 28 governorships, raising their number from 14, and picked up more than 300 seats in the state legislatures.

Having failed to use his veto pen during the first six years of his two administrations, as the Republican majority spent money like there was no tomorrow, President Bush suddenly discovered the veto, which had lain dormant in Article 1, Section 7 of the U.S. Constitution. Inheriting a fiscal surplus from President Clinton, the Republicans ran off seven consecutive deficits, only partly explained by expenditures in Iraq and Afghanistan.

Has Karl Rove turned gold into lead? Will his legacy be the great realignment of 2006 that resurrected Democratic Party control of Congress?

Friday, August 1, 2008

India, China, and Russia—Three Countries That Can Say No

The rise of India and China and the oil wealth of Russia have transformed the power structure of international relations. India refused to accept lower tariffs on several agricultural products, thereby scuppering the current Doha round of negotiations in pursuit of further liberalization of international trade. China reneged on its promise to allow unfettered press freedom for foreign media covering the Olympic games. Russia threatens to aim missiles westward, and perhaps curtail gas deliveries in winter, if the Czechs and Poles proceed with installation of a U.S. missile shield in Eastern Europe.

Sustained high growth and the accumulation of several trillion dollars of international currency reserves, largely held in dollars, have given the gang of three a much stronger bargaining position in international affairs. These trends are likely to continue for the foreseeable future, while the United States goes deeper in debt to foreigners.

No, bu, and nyet are words that American diplomats had better get used to hearing. The list of "no’s" is likely to grow in the future.

Wednesday, July 30, 2008

Stimulus or Stepped-up Tax Collection?

On February 13, 2008, President Bush signed the $168 billion stimulus package enacted by Congress. Democratic presidential candidate Barack Obama said on July 28, 2008, that an early act of an Obama administration would be an additional stimulus package, as much as $100 billion. The large projected budget deficits for the current and next fiscal years are attributable, in part, to the February stimulus package.

At the same time that Congress and the president are putting money in the hands of Americans to promote consumption and economic activity, the General Accounting Office reported new details on the federal tax gap—the amount of outstanding taxes owed by businesses and individuals. The purpose of the report is to recommend methods to collect unpaid taxes.

As of September 30, 2007, the federal tax gap due to unpaid individual and business taxes amounted to $282 billion. Of that, over 1.6 million businesses owed $58 billion in unpaid (not remitted) federal payroll taxes, including penalties and interest. Other unpaid business taxes totaled $50 billion, of which about half is corporate income taxes.

To the extent that the Internal Revenue Service succeeds in reducing the tax gap, it will vitiate the intent of the stimulus package and any future stimulus packages. The federal government needs to make up its mind. Should it hand out money and increase the deficit or try to collect unpaid taxes and reduce the deficit?

Tuesday, July 29, 2008

Russian Riches

It’s easy to understand why Russia is able to flex its muscles in international affairs and why Vladimir Putin is so popular with the Russian people. At the end of 1999, the country was broke, with a sharply devalued currency. On Boris Yeltsin’s sudden resignation, Putin became acting president on December 31, 1999. Putin was elected president in his own right on March 26, 2000. During his two four-year terms in office, Russia recovered from a great contraction in the 1990s and, in the past few years, has recorded strong growth and become a major market for exporters and foreign investment from the West and Asia.

Russia’s international reserves were a paltry $12.5 billion at the end of 1999. Since then, they have risen steadily, sharply accelerating in the last few years. Except for the July 2008 entry, the numbers are for the last week in December of each year.

2000: $27.9 billion
2001: $36.5 billion
2002: $47.7 billion
2003: $77.8 billion
2004: $124.5 billion
2005: $182.2 billion
2006: $303.0 billion
2007: $474.0 billion
7/2008: $588.3 billion

At the current rate of accumulation, Russia’s reserves are likely to reach $700 billion at year’s end and perhaps $1 trillion in late 2009 or early 2010. Russia will soon join the superpowers of international reserves, which includes China with $1.75 trillion and Japan with just over $1 trillion. Russia has gone from bust to boom in a less than a decade, just as the United States and Western Europe struggle to avoid a lengthy period of no to slow growth.

In international affairs, as in most matters, the golden rule applies: He who has the gold rules!

Monday, July 28, 2008

Staggering Deficits—The Law of Large Numbers

On July 28, 2008, the White House estimated that the budget deficit for the current fiscal year, FY 2007-08 (October 1, 2007 - September 30, 2008), will amount to $389 billion, and that the deficit for FY 2008-09 will be a record $490 billion. The explanation for these enormous deficits is a weak economy, which reduces tax receipts, and the $170 billion stimulus package approved by Congress earlier this year. The Congress plans to raise the federal debt limit from $9.815 trillion to $10.615 trillion, an increase of $815 billion, as part of the FY 2008-09 budget.

If elected, Senator Obama has said that his first legislative act as president would be another stimulus package, as much as $100 billion, to fix a broken economy. If $100 billion is good, wouldn’t $200 billion be better? $300 billion, anyone? This is a game of fiscal poker, which means higher future interest payments and greater dependence on foreign buyers of U.S. debt.

Millions, billions, trillions. Who can make sense of such large numbers? There is little point in attempting to save a few hundred million dollars here and there in government programs with deficits of half a trillion dollars.

Monday, July 14, 2008

Conservation: Hotword of the Day

With oil at $145 a barrel and gasoline exceeding $4.00 a gallon, we are implored to conserve energy. With drought in several regions of the country, we are told to conserve water.

To conserve is noble and uplifting. But what does it actually mean? In simple, non-inflated words: use less. Dictionary definitions include "to use carefully or sparingly, avoiding waste" and "to economize."

Using less is rather depressing. It means smaller cars, colder homes in winter and hotter in summer, shorter showers, and browner lawns, among others. Senator Obama has gone so far as to say that we may have to eat less to hold down food prices in developing countries. This is not the stuff of the American dream.

Private individuals are asked to conserve in all aspects of their lives. Why has no one said that the government has to conserve, to make do with lower taxes and less spending? Or does conservation really mean the transfer of resources from private individuals to government?

Sunday, July 6, 2008

Campaign Contributions: Biased or Balanced?

Individuals are permitted to give a presidential candidate a maximum of $2,300 for the primary elections and another $2,300 for the national election. Campaign treasurers are required to report monthly totals and list every donor that contributes $200 or more per donation. Multiple contributions in lesser amounts that aggregate in excess of $200 need not be itemized.

94305 is the zip code for Stanford University. Some 860 faculty and staff families live in campus residences along with about 10,700 undergraduate and graduate students. Many of the latter are foreign or out-of-state students and hence don’t vote in California. U.S. citizens can contribute regardless of their home address.

As of June 30, 2008, John McCain had received $6,900 from two Stanford residents, both fellows at the Hoover Institution. Barack Obama had received $107,991 from dozens of Stanford residents; of these, Hoover fellows contributed $5,850. If spouses of Hoover fellows are included, Obama received $9,100. On these numbers, Hoover is well balanced.

Thus far, Obama has received 94 percent of all contributions received from campus residents. Apart from two Hoover fellows, McCain has not received a dime from any Stanford resident. Is the rest of the campus biased?

Friday, July 4, 2008

You’re a Grand Old Flag—Or Are You?

July 4, America’s Independence Day, often brings out feelings of patriotism. Americans typically celebrate July 4 with family barbeques, along with watching parades, fireworks, and musical performances, which include such favorites as "Stars and Stripes Forever," "Yankee Doodle," and "You’re a Grand Old Flag."

Stanford University is blessed with lots of land. From its founding in 1891, the university has provided land on which its professors and high-level administrators could build homes and reside. The stock of housing has increased over the years, especially since the late 1950s, to some 860 homes, which consist largely of single family houses, a few duplexes, and several hundred condominiums. About 30 percent of the faculty and staff that is eligible to live on campus do so; the remainder live in the surrounding towns and cities.

During the early afternoon of July 4, my wife and I drove up and down all the campus streets housing Stanford faculty and staff. We counted thirteen flags in all, of which three were displayed in front of residences owned by Hoover Institution fellows (myself and two colleagues). Thirteen homes displaying the stars and stripes constitute 1.5 percent (halfway between one and two percent) of all campus faculty staff residences. Even neighboring Palo Alto has a higher percentage of homes displaying flags.

What is one to make of this minuscule display of affection for the national flag on Independence day among the faculty of one of the world’s greatest universities?

Thursday, May 22, 2008

Banana Dollar — Part 5

The saga of the falling dollar continues, in Ukraine of all places. Ukraine is one of the poorest countries in Eastern Europe, with a per capita income of about $1,500 in exchange rate terms and about $6,900 in purchasing power parity terms. Ukraine’s central bank, the National Bank of Ukraine, has generally fixed its currency, the hryvnia, against the dollar. In August 2005, it set the rate at 5.05 to the dollar. The dollar’s continuing slide contributes to inflationary pressure on countries whose currencies are fixed to the dollar. A stronger currency would help to reduce inflation by making imports cheaper, which brings down prices

To counter the impact of the weak dollar on Ukraine’s double-digit inflation, on May 21, 2008, the National Bank of Ukraine reset the hryvnia at a target rate of 4.85 to the dollar. Currency traders, anticipating further revaluation, pushed the hryvnia to 4.55 to the dollar, an appreciation of 10 percent.

Something must be wrong with U.S. monetary policy when such poor countries as Ukraine find it necessary to revalue their currencies against what was once the good-as-gold almighty dollar.

Wednesday, April 16, 2008

McCain’s Tax Reform—So Near And Yet So Far

On April 15, 2008, Republican presidential nominee John McCain fleshed out his tax proposals. Apart from some specific immediate measures that have been widely reported in the media, he called for a new and simpler tax system. At their choice, in place of the current Form 1040 and all the allowable deductions, individuals could file an optional one-page tax return that includes a doubled standard deduction and pay one or two rates depending on income. McCain did not specify either the rates or the level of income at which the two rates would apply.

We have been down the two-rate reform once before. President Reagan’s Tax Reform Act of 1986 consisted of two rates, 15 and 28 percent. It lasted until 1991, when his successor, the first President Bush, signed into law a bill that imposed a third rate of 31 percent. In 1993, President Clinton added two more rates, with the top rate at 39.6 percent. Two rates had a half life of less than three years.

So long as McCain was proposing an optional simpler system, he could have, indeed should have, proposed a real flat tax of one rate.

Friday, March 28, 2008

Banana Dollar — Part 4

The dollar continues to decline. Chinese exporters are increasingly quoting prices in renminbi (China’s currency, also known as the yuan, CNY). The yuan has steadily appreciated from $1=CNY 8.28 in July 2005 to CNY 7.01 in late March 2008, and is projected to appreciate further to CNY 6.30-6.40 by December 2008.

The Financial Times of March 28, 2008, reported that the vast majority of 700,000 Chinese suppliers to international companies no longer use U.S. dollars to settle non-U.S. transactions. Chinese exporters are also encouraging clients to pay in euros instead of dollars.

Since January 1, 2008, many foreign currencies, some previously weak, have markedly appreciated against the dollar: Japan, Switzerland, Chile, Colombia, and the Czech and Slovak republics more than 10 percent; Poland, 9.5 percent; Israel, 9 percent; and Hungary, in the midst of a budget crisis, 6.2 percent.

In the same issue of the Financial Times, Professor Martin Feldstein of Harvard, former chairman of the Council of Economic Advisers under President Reagan and former chairman of the National Bureau of Economic Research, writes that "the value of the dollar is not weak but is actually very strong." He goes on to say that "it takes a very large fall of the dollar to shrink the net [trade] deficit." He credits the weaker dollar for an increase in exports and a reduction of 11 percent in the trade deficit from its 2006 peak. (The current account deficit is running at an annualized rate of about $800 billion, due largely to high-priced oil imports.) In his analysis the dollar should continue to decline to reduce the large trade deficit. Given his words, that it takes a very large fall of the dollar to shrink the trade deficit, one can infer that he is willing to see another 30 percent or greater decline in the U.S. currency.

As I mentioned in "Banana Dollar" (January 21, 2008), the day will soon come when renminbi and Russian rubles will become hard currencies and the U.S. dollar a softer currency. The consequences for U.S. global status and power will be enormous and irreversible for years to come.

Wednesday, March 19, 2008

Banana Dollar — Part 3

Would you believe that Vietnamese now prefer their own currency, the dong, to the dollar. A Wall Street Journal story of March 19, 2008, reported that Vietnamese have suddenly lost confidence in the dollar, a currency that has been widely used in Vietnam as a matter of confidence and utility given that the largest denomination 500,000 dong bill is worth only about $31.

What happened? To curtail inflation, the Vietnam government has relaxed its exchange rate to allow the dong to fluctuate more freely against the dollar, from a daily range of 1 to 2 percent. In response, the dong has steadily appreciated since January 1 of this year from over 16,030 to about 15,855 against the dollar. In the gold shops and cafes, the dong is valued at a still higher 15,500.

Given the expectation of further gains, bank tellers have been turning away visitors trying to exchange dollars for dongs. Digital displays of exchange rates have been turned off. Vietnamese have been withdrawing money from dollar accounts to make dong deposits. Exporters are having trouble repatriating dollars for dong.

As noted in an earlier posting, India no longer accepts dollars at the Taj Mahal and other museums. Kuwait has abandoned its dollar peg in favor of a currency basket. Other Gulf States are contemplating similar adjustments. King dollar has fallen off its pedestal.

Secretary of the Treasury Henry Paulson keeps repeating the mantra that the U.S. wants a "strong dollar." As he continues to utter the phrase, if and when there is a real run in the dollar, he may find himself as the secretary who cried wolf once too often.

Thursday, March 6, 2008

Banana Dollar — Part 2

In a previous post (January 21, 2008) I noted that the term "banana dollar," a $10 occupation currency issued by the Japanese in Malaya during World War II with a picture of a banana tree on the obverse side, also came to signify a rapidly depreciating currency. The $1, $5, and $10 occupation notes retained their purchasing power during 1942-44. Rising prices led Japan to issue a $100 note in 1944 and a $1,000 note in 1945.

The history of U.S. currency since the Federal Reserve Board (fed) was established in 1913 is the opposite. Notes of $10,000, $5,000, $1,000, and $500 were first authorized in 1918, primarily for use in interbank transactions, but they also circulated in the hands of the public. The largest note ever printed was the $100,000 gold certificate, series 1934, featuring Woodrow Wilson. This series was issued only to Federal Reserve Banks against an equal amount of gold bullion held by the Department of the Treasury for certain credits established between the treasurer of the United States and Federal Reserve Banks.

On July 14, 1969, the Treasury and the fed announced that currency notes in denominations of $500, $1,000, $5,000, and $10,000 would be discontinued due to lack of use. Although they were issued until 1969, these notes were last printed in 1945. They remain legal tender and some still circulate, but most are in the hands of collectors. Since 1969, all high denomination notes that have been deposited at the fed have been destroyed. However, the secretary of the Treasury retains the authority to have printed, and the fed the authority to issue, all four high denomination notes. The fed’s web site displaying the volume and value of U.S. currency in circulation excludes data on denominations larger than $100.

Travelers to Europe learn that the European Central Bank issues euro notes in denominations of €5, €10, €20, €50, €100, €200, and €500. At current exchanges rates, it takes $760 to purchase a €500 note. From the dollar’s peak on October 26, 2000, when $0.88 was worth €1, to its low on March 6, 2008, when it took $1.54 to purchase €1, the euro appreciated 75% against the dollar.

Perhaps its time for Secretary Paulson to instruct the fed to reissue the $500 bill. However, the fed might consider commissioning a new design with bananas on the obverse side. Unless, that is, it decides to save bananas for the reintroduction of a the $1,000 bill.

Tuesday, March 4, 2008

Goolsbee Goofed

Chicago professor Austan Goolsbee, Barack Obama’s chief economic adviser, just learned a valuable lesson about politics. Be careful what you say. In a meeting with Canadian consular officials in Chicago. Goolsbee suggested that Obama’s anti-NAFTA stance was more about domestic political positioning than a clear articulation of policy plans.

It seems improbable that one ill-advised statement by an economic adviser will derail a presidential candidacy. If Obama wins his party’s nomination and the general election, Goolsbee is likely to join him in to Washington, D.C. In that event, I recommend that Goolsbee keep handy two works of literature.

One is a letter entitled "A Single Spark can Start a Prairie Fire," written on January 5, 1930, by Chinese Communist party leader Mao Zedong criticizing certain pessimistic views then pervading the party regarding the seizure of Jiangsi Province. The other is the conclusion from an old nursery rhyme composed by an unknown author about nails, horseshoes, horses, riders, battles, and kingdoms. "For want of the nail a kingdom was lost."

My advise to Goolsbee is simple. Trust no one in politics or the media, stay out of the limelight, and be content to work behind the scenes.

Tuesday, February 19, 2008

China Currency Catch-22

U.S. economic policy toward China has concentrated on getting China to revalue its currency, the yuan, with the objective of reducing its large current account surplus with the United States. The underlying theory is that a stronger yuan will raise China’s export prices, thereby reducing U.S. demand, and the weaker dollar against the yuan will increase China’s demand for U.S. products.

China began to loosen the fixed exchange rate between the yuan and dollar in July 2005. Since then, the yuan has risen 13.5% against the dollar, from $1=CNY8.28 to $1=CNY7.16. The higher prices of Chinese imports have begun to stoke inflationary fears in the U.S.

To cope with the U.S. economic slowdown and the prospect of recession stemming from the subprime mortgage crisis, the Federal Reserve Board has sharply lowered the fed funds rate from 5.25% in August 2007 to 3.00% on January 30, 2008. Financial markets expect another half-percentage point decline in the next month or two. The most important constraint that limits the fed’s ability to lower rates, and perhaps compel it to raise rates, is inflation.

Despite the steady revaluation of the yuan, the U.S. current account deficit with China increased in January 2008. As the yuan continues to appreciate against the dollar, projected at 7-10% in 2008, higher Chinese export prices will generate more inflationary pressure in the U.S.

The policies of lowering interest rates to prevent a recession or major economic slowdown coupled with a stronger yuan to reduce the trade gap, but which results in imported inflation, are incompatible. In this catch-22 scenario, what’s a poor secretary of the treasury and chairman of the fed to do?

Monday, February 11, 2008

Whither the Republican Party?

John McCain’s imminent annunciation as the Republican Party’s presidential candidate has set off a vigorous debate within the party. His primary and caucus victories are attributed to support from independent voters, crossover Democrats, and moderate Republicans. A McCain victory in November that rests on these voters means, in the view of some outspoken conservatives, a return to dominance of the old-line, establishment, moderate, Rockefeller wing of the party. To conservatives, McCain is the third stage in the undoing of Ronald Reagan’s legacy. The first was George H. W. Bush’s "kinder, gentler America" and the second was George W. Bush’s "compassionate conservatism."

Some prominent conservatives have stated their preference for a McCain defeat in November, which would enable them to try to rebuild the party on its conservative foundations.

In this regard, Canadian history may be instructive. The Progressive Conservative Party of Canada (PCP) was a party with a center-right stance on economic issues and a centrist stance on social issues. In modern times, the PCP formed the government from 1957 to 1963, from 1979 to 1980, and from 1984 to 1993. In the twelve elections for the House of Commons held between 1957 and 1988, the PCP never won fewer than 72 seats and on two occasions won more than 200 (308 members serve in the Commons).

Following the 1993 election, the PCP went into a decade-long decline and was formally dissolved on December 7, 2003, when it merged with the Canadian Alliance to form the new Conservative Party. The PCP had won a mere 2 seats in 1993, down from 169 in 1988, and a not much more respectable 20 and 12 respectively in 1997 and 2000. The explanations for the PCP’s collapse in 1993 and its decade-long exile in the political wilderness are attributable to its emphasis on socially progressive policies, large persistent government deficits, the introduction of a value added tax, the loss of support in Quebec, and the departure of conservative supporters in the four Western provinces of British Columbia, Alberta, Saskatchewan, and Manitoba to form a new party, the Canadian Alliance, which reflected the older conservative roots of the PCP.

In the 2006 Canada federal election, the new Conservative Party won a plurality of seats, 40.3%. It formed a minority government led by Prime Minister Stephen Harper, cofounder of the new party. In accord with its philosophy, the Conservative Party government cut the rate of value added tax.

The almost complete obliteration of the PCP in 1993 until its merger with the Canadian Alliance in 2003 and return to power in 2006, suggests that the Republican Party perhaps needs to undergo a similar defeat under its progressive wing for the party to reestablish its conservative roots.

Wednesday, February 6, 2008

Stimulate the Economy or Close the Tax Gap?

The president and Congress are on the verge of enacting a "stimulus package" in the neighborhood of $150 billion. It includes sending checks to taxpayers who earned less than $175,000 last year, possibly to Social Security recipients and veterans, accelerated depreciation for small business, and other benefits. The underlying belief is that putting money in the hands of people who are likely to spend it will increase demand, stimulate production, and create jobs.

Meanwhile, the White House and Congress appear likely to agree on a 4.3 percent increase in the budget of the Internal Revenue Service in order to close the "tax gap." The tax gap, the difference between what taxpayers owe the federal government in taxes and what the federal government collects, is estimated at $290 billion. A new measure includes stricter requirements for brokerage houses and other financial institutions to report what investors pay for stocks and other securities to the IRS, stricter enforcement of existing laws, increased audits, and increased penalties on those who willfully fail to file tax returns.

It took three years, from 2004 through 2006, to collect an extra $10 billion through stricter enforcement. A further $10 billion was raised in 2007, bringing the four-year increase to $20 billion. Closing the tax gap has been a priority of Congress and the IRS for many years. If the IRS makes significant progress in narrowing the tax gap, every additional dollar collected in taxes offsets, one-for-one, every dollar sent to taxpayers to stimulate the economy. Wouldn’t it be truly ironic if the IRS succeeded in cutting the tax gap in half during the next fiscal year!

Monday, January 21, 2008

Banana Dollar

The term "banana dollar" owes its origin to the ten-dollar bank note issued during the Japanese occupation of Malaya between February 1942 and September 1945. The obverse side of the note had a picture of bananas hanging from a palm tree. (One and five-dollar notes only displayed coconuts.)

The pre-occupation Malaya dollar was a standard currency board bank note in which each locally-issued note was backed by an equivalent value in sterling, set at M$1 = 2s. 4d. sterling, held in London by the Board of Commissioners of Currency Malaya. Japan chose to issue money in the currency of its occupied territories: Occupation money in the Philippines, Netherlands Indies, Burma, and the British Islands in the Pacific was designated, respectively, in pesos and centavos, guilders and cents, rupees, and pounds and shillings .

As Japan’s defeat became imminent, the banana dollar fell precipitously in value. Banana money thus came to signify a rapidly depreciating currency.

This historical footnote bring us to the U.S. dollar. Good as gold for much of its history, the U.S. dollar began to fluctuate in value after 1971 when President Richard Nixon closed the "gold window," the promise to exchange an ounce of gold for thirty-five dollars in U.S. currency. Since then the value of the U.S. dollar has fluctuated.

From January 1, 2001, to January 18, 2008, the dollar lost 54% of its value against the euro, 30% against sterling, and 32% against the Swiss franc. It has remained relatively stable against the yen, which reflects Japan’s weak economic performance during these years. The principal cause of the dollar’s decline is large U.S. current account deficits, $800 billion in 2007 alone. In order to correct this large deficit, the dollar must fall against foreign currencies to cheapen the price of U.S. exports, thereby increasing foreign demand for U.S. products, and raise the price of imports, thereby lowering U.S. demand for foreign goods. Due to the high cost of imported oil, about $500 billion a year, the falling dollar has made little headway in reducing the trade deficit. Foreign central banks and other holders of dollars have been losing trust in the U.S. dollar, gradually diversifying into other hard currencies. Russia’s large earnings from natural resource exports and China’s large trade surpluses have pushed the ruble up 23% since 2002 and yuan up 12% since July 2005. They stand to join the ranks of hard currencies in the not-too-distant future. How embarrassing for American tourists to learn that tickets to visit the Taj Mahal and other museums in India can no longer be paid in dollars, but only in rupees!

The expected decision of the Federal Reserve Board to cut interest rates at its next and perhaps following meetings, reducing returns on dollar-denominated bonds and other financial assets along with raising the specter of inflation, could make dollars even less attractive.

The dollar has gone from good as gold to a lower and lower valued piece of paper. Is it only a matter of time till a freshly designed Federal Reserve Bank note has a picture of bananas on it?

Monday, January 14, 2008

China and Kuwait to the Rescue of Citigroup

The sub-prime mortgage mess has blown huge holes in the balance sheets of America’s leading financial institutions. Analysts project that Citigroup will write off as much as $20 billion and Merrill Lynch between $10-20 billion in losses in their next quarterly reports. To restore their respective balance sheets, Citi plans to raise up to $14 billion and Merrill Lynch billions more.

Of the money for Citi, China’s government-owned and directed China Development Bank is projected to provide $9 billion, with the Kuwait Investment Agency and other public investors the balance. Kuwait is also prepared to put $4 billion into Merrill.

In 2007 China’s trade surplus with the rest of the world, largely concentrated in Europe and the United States, amounted to $262.2 billion, a monthly average of $21.9 billion. To put those numbers in perspective, the cost of U.S. military and civilian operations in Iraq and Afghanistan ran in the neighborhood of $200 billion over the last twelve months, a monthly average of $16.7 billion. Nine billion dollars from the China Development Bank amounts to about sixteen days of military operations in Iraq and Afghanistan, with Kuwait and other investor’s another 7 days.

Global free markets in goods, services, and capital flows are healthy for the world economy. But investments from China and Kuwait represent the acquisition of Citigroup equity by sovereign wealth funds or foreign government entities. This amounts to partial foreign nationalization of the U.S. financial infrastructure. If partial nationalization is required to restore the health of U.S. financial institutions, perhaps it would be better if the Social Security Trust Fund provided the resources. Much as one may dislike having Social Security take a stake in U.S. corporate equities, it can’t be worse than having the stake in Chinese and Arab hands.

The U.S. is fighting terrorism and trying to establish viable democracies in Iraq and Afghanistan. But these noble efforts may come at the price of increasing foreign ownership of the most important U.S. financial institutions.

Worse still, the United Nations Office on Drugs and Crime reported that opium production in Afghanistan reached an all-time high of about 600 million tons in 2006, nearly double that of 2001. (The Taliban regime was overthrown in November 2001.)

Friday, January 11, 2008

Afghanistan Agonistes

The United States has 17,000 troops in Afghanistan and is planning to send 3,000 more to forestall a possible Taliban spring offensive. The reason for the additional U.S. troops is because America’s European allies, which have supplied a smaller 11,000 troops, have failed to meet NATO’s request for an additional three battalions.

Between fiscal years 2001 and 2007, adding in 2008, the cost of U.S. military operations in Afghanistan will exceed $100 billion. To that number should be added $7 billion in U.S. civilian aid for reconstruction and development projects.

Private investment, in marked contrast, is minuscule by comparison, $690 million in 2004, $570 million in 2005, finally surpassing $1 billion in 2006. These include soft drinks, bottled water, cement factories, and mobile phones and telecommunications.

In a competitive tender that took place on November 20, 2007, on the $3 billion Aynak copper mine near the capital of Kabul, the China Metallurgical Group won out over two western, one London-based, and one Russian companies. Aynak is estimated to contain up to 13 million tons of copper, the second largest unexploited copper deposit in the world. In its January 9, 2008, edition, the Wall Street Journal wrote that the Chinese company offered the highest price in that it was most willing to accept the political, economic, and social risks associated with mining in Afghanistan.

Several inferences can be drawn from these facts. One is that security is so weak in Afghanistan that three western and one Russian companies were unwilling to risk $3 billion to secure a vast new source of copper. Another is that the U.S. has spent well over $100 billion in Afghanistan overthrowing the Taliban and trying to stabilize the Karzai government, but a potential victor could be China, which won the reddish brown prize.

Tuesday, January 8, 2008

Doubletalk

Secretary of the Treasury Henry Paulson appeared on Squawk Box on cable channel CNBC on January 8, 2008.

Paulson was asked if his good relations with China contributed to the recent appreciation of China’s currency. He credited China for letting its currency appreciate against the dollar, which is helping U.S. exports, but said that China needed to do more to liberalize its financial system.

Paulson did not blame China’s undervalued currency as the principal source of the U.S. trade deficit with China. He attributed it to a more fundamental problem, namely, the low level of domestic savings in the United States. In economic jargon, the gap between U.S. domestic investment and saving takes the form of a surplus on the capital account (net inflow of foreign capital). In accounting terms, a capital account surplus has to be offset by a current account (largely trade) deficit. Higher domestic savings would reduce U.S. dependence on foreign capital (foreign savings), thereby reducing the trade deficit. However, higher domestic savings comes at the expense of domestic consumption.

It is the fear of lower domestic consumption that gives rise to concern about a recession. In this regard, Paulson was asked if the U. S. should adopt a fiscal stimulus package (cut taxes and/or increase government spending) and cut interest rates to prevent the economy from falling into recession. He replied that he was not prepared to comment on interest rates, which falls under the ambit of the Federal Reserve Board. Nor would he discuss the specifics of a fiscal stimulus until the president had made up his mind.

A fiscal stimulus that increases the budget deficit constitutes an increase in government dissaving (that is, the government has to borrow more to pay its bills). Coupled with lower interest rates to spur consumption means a reduction in household saving, the fundamental problem that causes the trade deficit in the first place.

In the short run, fear of recession, especially in an election year, invariably exceeds concern about low domestic savings. The problem is that "for the moment" always seems to trump the need for more saving.

Monday, January 7, 2008

Why Americans Don’t Save

Economists bewail the low savings rate of Americans, noting that the U.S. depends heavily on foreign savings to finance the gap between domestic investment and domestic saving. The consequence of sustained low domestic savings is the transfer of ownership of U.S. real and financial assets to foreigners. As foreigners increase their holdings of U.S. assets, they gain greater influence on U.S. domestic and foreign policies. Those who doubt this outcome should remember the golden rule: "He who has the gold rules."

An increasing number of prominent economists are calling for the Federal Reserve Board to sharply cut interest rates, down from the current 4.25% federal funds rate to a much lower 3%, to prevent a recession and help the U.S. economy work through the sub-prime mortgage problem. If the fed complies, it would follow in the footsteps the fed took under Greenspan in the wake of the dot.com bust in 2000, when it cut rates to 1% and held them low much too long. Easy money was a principal factor causing the subprime mortgage mess.

One percent interest on loans and deposits had two harmful effects. First, it reduced returns to savers across-the-board, thereby discouraging saving. Second, as individuals reach retirement age, they tend to shift assets to more secure fixed-income instruments away from riskier equities. When returns on certificates of deposit fall from 5% to 1%, many elderly lose a substantial share of their non-social security income.

It seems that savers and the elderly are being forgotten once again in the rush to cut interest rates. Economists who are pushing aggressively for cuts in interest rates should not be surprised when they discover that the savings habits of Americans continue to erode. Perhaps the light will come on when many of them retire and become more concerned with interest income and less with interest cost.

China Building

China plans to build 5,000 kilometers of highways in 2008, bringing the total to 60,000. China plans to have built 85,000 kilometers by 2020, roughly equal to the United States, completing its inter-provincial highway network thirteen years ahead of schedule. In addition, in the two years 2007-08, China plans to complete the building or upgrading of 693,000 kilometers of roads in rural areas, tying more villages into the national highway network.

Meanwhile, U.S. roads and bridges continue to deteriorate.