The president seeks a fairer distribution of wealth; he claims not to admonish prosperity, but seeks to be sure it is shared.  There is a proven method to this noble objective and it lies under his nose. Instead of promoting it he is effectively destroying it.

In The Wall Street Journal, 1/26/12 Henry Nau writes Lessons from the Great Expansion.  (p A15 in the print version, the link may require a paid subscription, which I encourage.)

Excerpts:

Yes, “the middle class has shrunk,” as Mr. Obama said while campaigning last month. But not because it’s getting poorer, rather because it’s getting richer.

According to Stephen Rose of the Georgetown University Center on Education and the Workforce, fewer people live today in middle-class households with incomes between $35,000 and $105,000, while the percentage of households making less than $35,000 has remained the same. Where did the missing households go? They became richer. In the past three decades, the percentage of households making more than $105,000 in inflation-adjusted dollars doubled to 24% from 11%.

Even more importantly, the global surge in growth spread wealth from the rich to the poor countries, creating greater equality in global markets than ever before. Throughout this period, developing countries grew two and even three times faster than developed countries. As a result, the share of world GDP held by emerging markets increased to 22% from 13%, while the U.S. share remained steady at approximately 26%. The “Great Expansion” created a global middle class of some 600 million-800 million people in China, India, Brazil and other developing countries.

What were the policy trends that produced this Great Expansion? Precisely the free-market policies of deregulation and lower marginal income-tax rates that Mr. Obama decries.

HKO Comments:

Capitalism replaced the feudal societies where capital was allocated based on rank and privilege with an allocation based on merit and innovation.  The re-emergence of a more state controlled economy is in a very real sense a return to allocating capital based on privilege and power as opposed to individual merit and freedom. By overreacting to a short period of correction and adjustment this administration risks damaging the very best system for achieving the objectives he claims to value so highly.

Too much money makes many people stupid. After the prosperity and growth of the 1980’s, Clinton thought that he could expand the prosperity to more people by enacting government programs without consequences.

In the Investor’s Business Daily editorial, Bill Clinton, Home Wrecker, the writers explore the policy that began the housing bubble and collapse.

Rewind to 1994. While everyone was worried about Clinton socializing health care, he was busy socializing mortgages. To boost minority homeownership, Clinton toughened anti-redlining rules and launched a federal assault on mortgage underwriting standards.

He enlisted no fewer than 10 federal regulatory agencies to crack down on prudent lenders. He named his anti-bank SWAT team the Interagency Task Force on Fair Lending.

“I want to target new (housing) markets, underserved populations, tear down the barriers to discrimination wherever they are found,” Clinton said. “We have to do a better job of reaching the underserved; of eradicating discriminatory practices that prevent minorities from finding, financing or buying the home of their choice.

“We can widen the circle of homeownership beyond anything we have ever seen,” he added.

Indeed, Clinton’s policies for the first time threw millions of previously unqualified buyers into the mortgage mix, fueling an unprecedented housing bubble.

Between 1995 and 2005, according to a new book, “The Great American Bank Robbery,” minorities accounted for nearly two-thirds of household growth and contributed a whopping 49% of the 12.5 million rise in homeowners over the decade.

HKO comments:

It is hard to avoid the desire to share the wealth when there is plenty to share, but when this overrides basic prudent lending standards then the prosperity shared is short lived and in this case very destructive.

This does not excuse reckless leverage in the case of the banks, but it does raise the risk of regulators who are pressured politically to become blind to reality.

Too much money often makes for bad decisions in the private sector as well, but it is more likely to cause systemic failure when it precipitated by the volume, power and force of government.

The president’s jobs bill is a non starter, a desperate attempt to do something by doubling down on failed policies.

Point  one- He offers tax breaks to workers by extending the reduction in FICA taxes, and making up the deficit with higher taxes to the general fund.  He promotes  incentives to get employers to hire the chronically unemployed and to raise wages, yet plans to fund this effort by raising taxes on the same employers.

Point two-  While he demagogues about the millionaires and billionaires, the truth is that there is not enough of them to fund his programs and thus he has to define ‘rich’ down to include the small business people which he cherishes in rhetoric but clearly knows nothing about.

Point three- Businesses do not create long term jobs with short term incentives.  After the ‘tax breaks’ wear off, the business is left with the full fare for the new jobs.  Often creating such jobs  requires investment in new equipment and those pieces of machinery still cost after the incentives have expired.

Point four- The bureaucracy required to utilize these tax credits, and the conditions are so onerous that few of the small business will be able to use them.  If you are only able to hire a few workers it just isn’t worthwhile to ramp up and learn how to comply with an incentive that will only last a few years.  Like most other regulations it is an advantage to larger companies with the infrastructure and the mass to justify the expense of compliance.

Point five-  By giving incentives to hire the chronically unemployed we are creating a perverse incentive to penalize the workers who have NOT relied on the largesse of the extended unemployment benefits.  If I have a choice between two workers and one has been unemployed for a month and the other has been unemployed for a year, I will lean more toward the one who has not been out of the work force for so long.  I will question the work ethic of the worker who has managed not to work for a year.  The advantage of the proposed tax break will not offset the natural incentive to hire a worker with a better motivation. This may seem unfair, but  trust me- this is how most small business employers will think.

At a recent business conference owners and employers from several different small businesses told similar tales.  I could sum it up with two observations: Generous unemployment benefits have made it hard to hire low level jobs such as dishwashers and busboys, and the uncertainty of pending regulations and tax increases has stifled business incentives to expand.  For the amateur economists in the room (and there were several professional economists there as well) it seems obvious that if you create incentives such as generous unemployment benefits not to work, and you also create incentives not to hire (Obamacare, Dodd-Frank, NLRB, higher taxes pending) then you should not be surprised if unemployment remains high.

When reading and reflecting on the history of our economic and financial condition it appears that we get it wrong more often than we get it right. Just as our history is a history of wars with brief interim periods to rebuild and reload (often referred to as ‘peace’), our economic history is a story of moves to extremes with interim periods of relative stability.

Political hands on the machinery of the economy is just too tempting to resist.  Monetary, financial, fiscal, and economic policy can become quite complex particularly in a world where exchange rates continuously adjust the relative economic power of nations. Global systems that work in a period of peace may work poorly in times of war; systems designed to assure balance among friendly nations may work poorly among nations at philosophical or political odds.

While few voters comprehend the complexities of administering economic policy, it would be a mistake to assume that our political leaders understand it much better. And while the average voter may not understand the nuances of economic philosophy they understand the results very clearly.

High unemployment and high inflation are not easily recognized until they change rapidly or drastically .  Economic growth and new product innovation is appreciated by many even if it gets buried in the cynicism that masquerades as political analysis.

In the last 100 years only four presidents got it right.  Coolidge, Kennedy, Reagan and Clinton practiced a combination of sound money and lower taxes. In each case the economy boomed afterwards. Their effective policies were undone by their successors; Hoover and FDR after Coolidge, Johnson and Nixon after Kennedy, George W Bush (who only got it half right) and Obama after Reagan and Clinton (with a brief lesson from ‘read my lips’ George H. Bush). It is worth noting that neither party has maintained a monopoly on economic competence or incompetence.

The tumultuous twentieth century demanded adjustments that our leaders were ill prepared to understand. Global monetary developments caused the rise of the economist as a central policy figure. Keynes’s deficits and stimulus became accepted more because of the rising popularity of central planning than because of any evidence that it actually worked. Milton Friedman’s monetary school focused more on monetary policy as a stimulus as opposed to active government intervention into the economy. While Friedman’s vantage focused more on individual liberty and freedom, Keynesian policies were favored more by those who wanted the government to force greater equality and social justice.

Better results were achieved by Robert Mundell (Nobel prize 1999) and his better known advocate,  Arthur Laffer

Pushing businesses to extremes in efficiency is destabilizing.  Tax codes that created incentives for debt over equity created leveraged companies that sought greater efficiencies to accommodate the structures. But as Nassim Taleb has pointed out, efficiency is a form of leverage. When you are running at maximum efficiency there is no magic hat to pull out further cost reductions when truly bad times hit. This causes recessions to be more severe.

Policies enacted when the economy is booming seem free of consequences. Raising the minimum wage 40% ( $5.15 to $5.85 in 2007, to $6.55 in 2008 and to $7.25 in 2009) seemed like a good idea at the time, but its impact on the unemployment rate of the young has proven disastrous.  Yet reducing the minimum wage has become a risky battle in the class war.

More than the content of the tax codes and regulations themselves is the rate at which they change. We cannot have a stable economy when tax rates and regulations change every couple of years. Not only do the changes themselves inhibit growth, but the constant talk and debate leaves investors always wondering.

It is bad enough when this political volatility simply makes businesses and investors think in the shortest possible terms. We have reached a point where the regulations, both passed and pending, is squelching investment altogether.

The debt downgrade is not good, but not all that happens as a result is bad.  No matter how pathetically this result is spun to reflect on the Tea Party, intransient Republicans, and George Bush the administration cannot escape responsibility.  He took a giant Keynesian gamble and it has failed miserably, as it has in the past.  I am more surprised by how well the economy has performed given the dramatic shift to centralist government under this president.

Businesses are sitting on huge sums of cash and they are not spending it because of the atrocious regulations and new laws and the stepped up class warfare.  Wealth goes where it is wanted and respected, not where it is demonized.

But cash is also sitting idle because interest rates are low.  If normal investments are too risky and short term yields are too low there is only one other place for it to go and that is consumption.  That is what Keynes would anticipate.  But the wake of unwinding excess credit has pushed more cash into reducing debts than increasing consumption.  Savings is growing.

It is worth noting that Apple computer has more cash than the Treasury. (My family of three has eleven Apple products.) Perhaps we will find that private businesses manage resources much better than the government and we will deploy more resources in that direction.  The 500 point decline  may have been triggered when a large New York bank began to charge large depositors for holding cash in effect making short term interest rate turn negative, which it already was if inflation was considered.

In this environment the best deployment of cash is to reduce debt. You earn nothing on your cash but you can assuredly save 5% or more by paying off your mortgage.  Not paying 5% is the same as earning 5% and the savings is with lower risk.

Low interest rates is a way of saying there is too much money in circulation OR that the demand for money or the velocity or turnover of money is too low.

This debt debate and the ensuing downgrade is testament to the fact that the current administration and the current political leadership is unwilling to make the reductions in spending necessary to restore our credit rating.  Only the next election can remedy that. But a reduction in government spending alone will not redeem our standing.  Much of the regulation and legislation passed in the  last few years must be reversed.  At the risk of being repetitive,  loose monetary policy can no longer bail out reckless fiscal policy.

If we ONLY reduce the demand that would come from a reduction in government spending WITHOUT stimulating production the drop in spending will likely trigger another recession.  If such a  recession ends up reducing government spending it would be an investment ultimately worth making.  The last round of spending to lengthen unemployment benefits and stimulate green jobs did little to nothing to stimulate anything of long term value.