Fareed Zakkaria in Newsweek writes of the good that will come from this financial debacle. We will return to sanity and common sense in our financial world. We will reduce our over reliance on debt as a country, in business and in our personal lives.
Unwinding a debt addicted culture will be painful. It will be harder to sell cars, homes and other large ticket items. It will be a form of deflation. A sharp reduction in debt is like a contraction in the money supply.
In an economy with increasing money supply cash is a liability since prices continuously rise. In this economy cash is king. Suppliers will be slashing prices to compete for your business but it will be harder to buy with anything less than stellar credit. No one wants to repo your car when there is no market for the new ones.
In an inflationary environment you pay off debt with cheaper dollars; debt is encouraged. In a deflationary environment it is more difficult to pay off debt with dollars that are more valuable.
Stay with me here.
The government has now taken on massive debt at a time when tax revenues will decline sharply. Business profits (and therefore tax payments) are plummeting. Unemployment payments will increase. Higher capital gains and dividends tax RATES will reduce the DOLLAR income from those resources just as they have every other time in the last 100 years that they were increased.
We addressed the Y2K crisis, the 9/11 crisis and every other crisis with easy money (inflation). It seemed like a good idea at the time but when it is used to address every problem without getting a breather to return to sound money, it only makes the eventual reconciliation more painful.
Hopefully the government’s ‘investment’ in our banking system can be returned with a profit, but it would be vary naïve to expect these institutions to return to their precrash levels any time soon.
I have certainly seen no heart in Congress to even begin to make cuts to offset this rescue plan. In fact they see the rescue as an opportunity to add even more pork spending to the bloated bill. With a big debt and declining revenues there will be a temptation to inflate our way out of this problem as well.
The best possible hope is to free up the capital markets as much and as fast as possible. This means cutting the corporate tax to zero, and eliminating capital gains tax completely. This is the exact opposite of what the party about to control our government recommends.
This may seem an abomination to those who preach that we must “share the wealth”, but the likely alternative is that we will “share the poverty.”