Crash Course in Economics

The first time I was in a car crash, I was six or seven years old.

That's a long time ago. But there are certain things about it that I remember quite vividly.

My father was driving. The road was icy. We began to slide. This was in the days before seat belts and cars had bench seats, upholstered, but not shaped for each individual bottom. My father shot out his right arm and pressed me against the seat back to keep me from flying forward if, indeed, we ended up in hitting something.

The thing that was most extraordinary was how long it seemed to take. How time slowed while we slid forward and sideways, heading onto the shoulder, then past it .... it seemed as if we had all the time in the world, yet there was nothing we could do to get off the ice, alter the trajectory, slow down ... nothing ... until we crashed.

As I read the economics news, I'm having that exact same sensation, that we're in a slow motion crash.

Each week, sometimes daily, we slide by a new warning sign, by another wreck that's already off the road.

The new one is Lehman Brothers.

Before that Fannie Mae and Freddie Mac. Before that Bear Stearns.

In August, "one in every 416 U.S. households entered the foreclosure process." In spite of a 2005 law that made personal bankruptcies more difficult and that allows creditors to squeeze money out of people even after they've gone bankrupt, personal bankruptcy rates are soaring. General Motors stock has been trading at 1950s prices. Like GM, Ford is laying off thousands of workers. Both of them are asking for federal assistance to survive. Pension funds are routinely failing.

Then there are my personal experiences.

Like when I go to the gas station and watch the ticker on the pump go up over fifty, sixty, and then seventy dollars to fill the tank. Or when I go to the supermarket and lay down a hundred and forty dollars for what cost me a ninety a year or so back.

From time to time I run into rich people or their handlers. Last February I was traveling with a lawyer from one of New York's leading law firms. He does the legal work on IPO's. He told me their January, 2008 business was down 90% from January, 2007. A couple of days ago a hedge fund guy dropped in on our regular tennis doubles game. Between sets he mentioned how hard it was to get credit these days. "On a secured loan," which means 40% backed by assets, mostly commercial real estate, he was talking about $120 million and up, "the banks want 20% interest."

Every analyst that I see or hear blames it on the "housing bubble" and the "sub-prime mess."

That doesn't seem right.

It doesn't explain why the dollar has lost about a third of its value against the Canadian Looney and the Euro, among others. Or why gold is bouncing up against the $1,000 ceiling. Both of which happened before the bubble sprung a leak.

It doesn't explain why the stock market - as measured by the Dow Jones average - is down (adjusted for inflation) about 15% from 2001. Moreover, at its peak during the Bush years, it was only 14% (adjusted) over the 2001 mark.

It doesn't explain why median income is down - depending on who's reporting it - $700, $1,000, $1,200 per person, over that same time period. Even median family income, with more people working per family, is down.

It doesn't explain why, during the so-called Bush boom, corporate profits were at an all time high, but corporations were starved for places to invest the money.

Let us presume that government policy has an effect on the economy.

What are the policies that have produced this economy?

The one that's on an icy road, sliding, in slow motion, toward the cliff. Or, if we're lucky, maybe just into a ditch.

The core, the very heart of Bushonomics, is cutting taxes. Especially for the wealthy.

I find it impossible to figure out what George Bush's motivations for anything are. He may have that impulse because he himself, his family, and his friends are all very rich and they'll save themselves millions of dollars over the years. Maybe it's political. As he once said, the super rich are his "base." It may be a class thing - the belief that rich people are rich because they're better and will do better things with the money. It may be theological, the mystical belief that "the market" makes everything better.

Whatever the truth is, the tax cuts were sold as economic stimulus and jobs packages with the promise that they would not create deficits. This last was based on a romantic Ayn Rand vision of millionaires racing into the backwoods to build, build, build new businesses which would create jobs, "good jobs," and new taxes would be paid by the businesses and the workers, making up for the initial deficits.

Alas, none of that ever happened.

Deficits were created.

Bush went on a war spending spree. That made them bigger. Whatever boom there was did not create sufficient revenue to the government to make up for deficits.

That triggered the next event in our saga.

Deficits normally lead to inflation.

Bankers hate inflation. So do politicians.

So Allen Greenspan, everyone's favorite economic hero, stepped in. He cut the rates that the Federal Reserve charged banks to borrow from the government.

The intent was to keep inflation low.

It sort of worked for about five years. The official, and actual, rates of inflation were pretty low.

The reason I say it only sort of worked was that, in reality, it suppressed inflation. It made the dollar worth less. As we now know, at least one third less. Oil, as it happens, is priced in dollars. Overseas suppliers of oil began to see their incomes decline. By about a third. So they did what any sensible person with the power to do it would do. They began to raise their prices.

That does not account for the full rise in the price of oil, but it triggered it, and it's a large segment of it. Since everything in America moves on oil, it's raised the cost of everything else. It doesn't account for all the cost increases we're seeing now, but it propels a significant portion of them.

This was combined with several other impulses.

Free trade has to be number one on the list.

Free trade brought cheap consumer goods into the United States from overseas. That made shoppers very happy. It kept inflation down.

It was tough on workers. It not only put a lot people out of work directly, it put downward pressure on wages all across the board. That too, helped keep inflation down.

It was also very tough on businesses that actually make things here, in the United States. The making of things, and then the support services, were outsourced, though the companies remained here, as corporate and marketing entities.

Other factors include de-regulation, non-enforcement of regulations, appointing industry representatives to regulatory agencies, and union busting.

With out-sourcing and domestic wages going down, corporations did, indeed, make record profits.

Three things came together to produce a great deal of loose cash.

First, the government cut taxes while it increased spending.

Second, the Federal Reserve made it cheap, artificially cheap, to borrow money.

Third, corporations made money - largely by pushing wages and salaries down - but had no place to put it.

But, what was there to do with all that money?

There was no place nothing being produced with the right kind of growth potential to pay back the loans. Working people were not making more money that could be used to create more consumption.

So the great ocean of money went, ultimately, to two places, from which it was supposed to be paid back - real estate and to consumers (who were making less income) for personal spending on credit.

There was growth. About a 37% increase in the GDP in actual dollars across seven years. That's about 17% in inflation adjusted dollars.

Let's go back and look at two other numbers, median income and the stock market.

They're both down.

Where was the growth?

It was in borrowing. In credit. In debt.

There's one bubble, the housing bubble, which is inside of - or a symptom of - a much larger bubble, the credit bubble. That bubble is so big that it represents almost the entire growth in the US economy for the last seven years.

At the core of it, the seed from which the poison fruit has grown, are the tax cuts.

Do tax cuts actually stimulate the economy?

Vast sums of money have gone into creating that myth. Major intellectual industries have been created and sustained to sell that story.

At the center of that claim is the Legend Of Saint Ronald Retro Reagan.

Reagan cut income taxes, big time. But raised social security and medicare taxes. That meant that rich people paid less and working people paid more. The immediate result was that economy faltered.

Then Reagan raised taxes (though not by as much as he cut them). At about the same time, oil dropped from forty dollars a barrel to twenty. The economy did grow. That is until the stock market crash of '87.

There is vastly more evidence the other way. Tax increases stimulate the economy.

It may not make sense, it may be counter intuitive, but here are the facts.

What if taxes went up to over 90%?

According to the Reaganauts and Bushwackers the world would collapse! Business would grind to a halt. Investors would flee. Workers would lay down their tools.

Back in World War II, taxes did go up that high.

Americans who earned as little as $500 per year paid income tax at a 23 percent rate, while those who earned more than $1 million per year paid a 94 percent rate

The result:

The American economy expanded at an unprecedented (and unduplicated) rate between 1941 and 1945. The gross national product of the U.S., as measured in constant dollars, grew from $88.6 billion in 1939 - while the country was still suffering from the depression - to $135 billion in 1944.
EH.net (from Economic History Services)

From 1946 to 1963 the top rate fluctuated from 86% to 91%.

Average economic growth was 3.5% per year.

The current top income tax rate is 35%.

Economic growth has been, at best, 2.5%. That is if you stop counting in 2007. And don't consider the type of growth, which consisted primarily of increased debt and pyramids of borrowing.

In 1992 the top tax rate was 31%.

Bill Clinton increased it to 39.1%.

The Dow Jones average went up 360%. The number of jobs went up 237,000 per month (under Bush, as of 2007, it was just 72,000 per month.). Median household income went up (instead of down). The budget was balanced.

Both candidates are talking about tax cuts to fix the economy.

Does that make sense?

Here, in NY State, we are facing a budget crises due to the collapse in the financial markets which is where a lot of our tax revenue comes from.

The governor has a choice between raising taxes and cutting expenditures. He's a good, fairly liberal Democrat. But he polled the people and the legislature, and everyone wanted to cut spending.

That means cutting the state work force.

That means that people who had jobs and were spending money will be unemployed and spending a lot less. That means less revenue for the state and for the places that they did business with. Which means the economic crises will grow worse.

States are in a difficult position because they compete with each other for "friendly business environments," which always means, in the short term, low taxes.

This administration, and most economists, at least as they appear in the media, want us to "consume" our way out of trouble.

But the model should be the other way. We should be producing our way out of trouble.

Is that possible in a "free trade" world?

The answer is yes. Through government spending. Through the kinds of things that the market cannot, or will not, supply.

The market will not protect our coastlines. How many Katrina's and Ike's do we have to have before we understand that it is in the common good - and good for business and good for the economy - that we do so.

Most of the costs of doing so cannot be outsourced. They have to, by their nature, stay here.

The same is true for wind and solar power and rebuilding our electrical grid to make such power sources work.

The market will not produce sensible, affordable health care. The market, in fact, has produced the worst cost-to-benefit ratio in the civilized world. The market has produced more bureaucracy in health care than any government agency ever could.

An affordable, national health care system will make American business more competitive.

For those of us who pay for our own health care, it will leave more money in our pockets than most of the tax cut proposals.

The market cannot and will not produce clean air and water. It will not produce an educated population.

Why did we have so much growth - so much business growth - when we had high taxes and when the taxes on corporate profits were actually collected?

If taxes on income (personal or corporate) are high, the impulse is not to take them. Especially if they're as high as 90%. Though there's no need to go that high to start making a meaningful adjustment.

What do companies and people do when they're making money in a high tax environment? They reinvest. In producing something. Cashing out is difficult, but the value of what they own continues to grow as the reinvestments pay off. We then have to "make money the old fashioned way ... earn it."

There is a difference between my business and "business," the wealth of the nation.

In my business, I hate regulations, unions, and high taxes.

In my country, I appreciate regulations, unions, and what high taxes, if intelligently spent, do for me. Then I live in a country in which business in general does better, my investments in the stock market do better, my retirement is protected, my children's health care is affordable, and I have more hope for their future.