Free Markets, Free People

Economics

Meanwhile In California …

The expected happened:

California voters soundly rejected a package of ballot measures Tuesday that would have reduced the state’s projected budget deficit of $21.3 billion to something slightly less overwhelming: $15.4 billion.

The defeat of the measures means that Gov. Arnold Schwarzenegger and the state Legislature will have to consider deeper cuts to education, public safety, and health and human services, officials have said.

Propositions 1A through 1E – which would have changed the state’s budgeting system, ensured money to schools in future years and generated billions of dollars of revenue for the state’s general fund – fell well behind in early returns and never recovered.

The only measure that voters approved was Proposition 1F, which will freeze salaries of top state officials, including lawmakers and the governor, during tough budget years.

Schwarzenegger, however, still doesn’t get it:

In a written statement Tuesday night, Schwarzenegger said that he believes Californians are simply frustrated with the state’s dysfunctional budget system.

“Now we must move forward from this point to begin to address our fiscal crisis with constructive solutions,” the governor said.

In reality it has nothing especially to do with the state’s “dysfunctional budget system”, but instead with the state’s profligate spending which has landed it in overwhelming debt. And the most “constructive solutions” would be to – wait for it – cut spending.

Why is it I have a feeling that such a solution will be mostly absent from whatever CA legislators come up with?

~McQ

Quote of the Day

Although Herbert Hoover is rarely cited when one thinks of “immortal words”, these few paragraphs from Hoover (from James T. Flynn’s “The Roosevelt Myth”, HT: the Heritage Foundation) should certainly give you pause:

In every single case before the rise of totalitarian governments there had been a period dominated by economic planners. Each of these nations had an era under starry-eyed men who believed that they could plan and force the economic life of the people. They believed that was the way to correct abuse or to meet emergencies in systems of free enterprise. They exalted the state as the solver of all economic problems.

These men thought they were liberals. But they also thought they could have economic dictatorship by bureaucracy and at the same time preserve free speech, orderly justice, and free government.

These men are not Communists or Fascists. But they mixed these ideas into free systems. It is true that Communists and Fascists were round about. They formed popular fronts and gave the applause. These men shifted the relation of government to free enterprise from that of umpire to controller.

Consider the “car czar”. Look at the Chrysler board. Imagine government run health care. Cap-and-trade. Etc.

After that bit of reality from today, read Hoover’s further observations:

Directly or indirectly they politically controlled credit, prices, production or industry, farmer and laborer. They devalued, pump-primed and deflated. They controlled private business by government competition, by regulation and by taxes. They met every failure with demands for more and more power and control … When it was too late they discovered that every time they stretched the arm of government into private enterprise, except to correct abuse, then somehow, somewhere, men’s minds became confused. At once men became fearful and hesitant. Initiative slackened, industry slowed down production.

Look around you and tell me what you see. The future? It’s to be found in Hoover’s words from 1940.

~McQ

Tax The Rich? Watch The Inevitable Happen

Many states have decided the financial relief they need to make up for their profligate spending sprees of the recent past and their present budget short-falls is to be found in raising the taxes of their “rich” citizens.

With states facing nearly $100 billion in combined budget deficits this year, we’re seeing more governors than ever proposing the Barack Obama solution to balancing the budget: Soak the rich. Lawmakers in California, Connecticut, Delaware, Illinois, Minnesota, New Jersey, New York and Oregon want to raise income tax rates on the top 1% or 2% or 5% of their citizens. New Illinois Gov. Patrick Quinn wants a 50% increase in the income tax rate on the wealthy because this is the “fair” way to close his state’s gaping deficit.

But there’s a problem with the plan. As the WSJ points out, these citizens and their money are mobile and while they may prefer to live in the states listed above, they simply don’t have too. And with the plan to significantly increase taxation for them, now there’s a good reason not too:

The tax differential between low-tax and high-tax states is widening, meaning that a relocation from high-tax California or Ohio, to no-income tax Texas or Tennessee, is all the more financially profitable both in terms of lower tax bills and more job opportunities.

Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts.

Notice that the exodus from the high-tax states to low-tax states with more opportunity has been significant since 1998. But now with the plan to increase taxes again on the “richer”, high-tax states are providing even more of a financial incentive for those in higher income brackets to leave them and move to low or no-income tax states. While such a relocation might have had marginally positive financial results for those leaving in the past, high-tax states are about to make relocation for financial reasons a no-brainer. And states like California and New York can hardly afford to run off the class of tax payer that presently pays the largest percentage of state taxes.  But, with alternatives available, that’s precisely what they’re getting ready to do.

And when that happens, who ends up making up for the state’s shortfall?

More recently, Barry W. Poulson of the University of Colorado last year examined many factors that explain why some states grew richer than others from 1964 to 2004 and found “a significant negative impact of higher marginal tax rates on state economic growth.” In other words, soaking the rich doesn’t work. To the contrary, middle-class workers end up taking the hit.

Heh … what a surprise.

~McQ

Predicted vs. Actual

Here’s an interesting little chart I found at Innocent Bystanders.  The light blue line is the Obama administration’s prediction of how terrible unemployment would be if we didn’t pass the stimulus plan.  The dark blue line is the prediction of how much better things would be we did pass it.  The dark red triangles show the actual unemployment statistics.

The Amazing Effectiveness of Stimulus

The Amazing Effectiveness of Stimulus

So, how’s that recovery plan working out for us?  Not so good, apparently.

I merely provide the chart for informational purposes.  I know it’s useless to make any criticisms of the actual performance of the plan, just as it was useless to predict that this is pretty much what would happen.

Besides, saying, “I told you so”, is so churlish and mean.

Podcast for 10 May 09

In this podcast, Michael, and Dale discuss the county’s failing energy and economic policies.

The direct link to the podcast can be found here.

Observations

The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.

As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2007, they can be accessed through the RSS Archive Feed.

How To Kill An Economic Recovery

Hugo Chávez is in the news again, appropriating and nationalizing more of the oil industry in his country.

That sort of move by him has become so routine that it almost isn’t news anymore. But this particular sentence caught my eye and reminded me of what we’ve seen here as well:

This move forms part of a broader assault against the private sector, which Mr Chávez has increasingly blamed as Venezuela slides into recession.

Vilification is a political tactic in use by a certain type of politician, and anyone paying attention to what has been going on in this country has seen it deployed in earnest against the wealthy and certain industry sectors in the US in the last few months. The health care industry is next. And, as in Venezuela, the government is being offered as the best alternative. Yet watching Venezuela, most understand the ramifications of moves such as Chavez is making on the long-term viability of Venezuela’s economy:

But analysts say that by shifting its problems onto its suppliers, PDVSA is storing up even bigger problems for the future. Not only does it lack the ability to operate as efficiently as the service providers, but it sends a grim signal to companies considering investing in Venezuela. Consequently, future oil production is under threat.

While the moves taking place here aren’t as drastic as those in Venezuela, they’re just as problematic. Government appointed board members on auto company boards and government calling the shots in the financial sector aren’t direct takeovers, but they portend a level of government meddling unseen here before. And health care and energy are next.

The key word in the quoted paragraph above is “investing”. Investors are very wary about both the auto and financial industries at this point. They’re wary of the auto industry because government is essentially throwing the bankruptcy procedures out of the window and those investors which should be guaranteed the first seat at the table for the recovery of their investment are now being vilified as “greedy” and pushed to the side. Any reason they or any other investor should take a monetary stake in either of the government controlled auto companies again? And given the experience with autos, don’t you suppose investors in the financial sector are having second thoughts?

Investment is the road to recovery in recessionary times. The moves Hugo Chávez is making in Venezuela are exactly the wrong moves in terms of economic recovery (not to mention being a complete violation of property rights). While not as drastic as Chávez, the moves the Obama administration have made are sending a similar signal to investors.  And that doesn’t bode well for a swift economic recovery.

Health care and energy are next.

~McQ

Another Troubling Sign

What if the Treasury held a bond auction and nobody came?  After today, that’s not a rhetorical question.

Weak demand at a Treasury bond auction touched off worries in the stock market Thursday about the government’s ability to raise funds to fight the recession.

The government had to pay greater interest than expected in a sale of 30-year Treasurys. That is worrisome to traders because it could signal that it will become harder for Washington to finance its ambitious economic recovery plans. The higher interest rates also could push up costs for borrowing in areas like mortgages.

We are moving closer to what I warned about in March, after the UK had a failed auction of 15-year gilts.  Apparently, the Chinese didn’t turn out in force today.  They did however, continue talking about a new reserve currency–one that isn’t the US Dollar.  And apparently they’ve been doing more than talking about it.

As we learned last week, the Chinese–who haven’t announced anything about their gold holdings since 2003–casually dropped an announcement that they’d nearly doubled their gold holdings from 19 million to 34 million ounces.  Moreover, this gold, which had previously been kept for foreign trade in an account at the State Administration of Foreign Exchange, has now been transferred to the bank of China, as part the country’s monetary reserves.

I don’t think they’re all that keen on lending us money any more.

This is important because it indicates the extent to which gold is being rehabilitated as a monetary reserve asset, not only by the Chinese monetary authorities but by central bankers around the world. It has been clear that gold was being restored as a more important part of the world’s financial system, with rising investment demand over the past nine years. The Chinese government’s decision to say that this gold belongs in its monetary reserves emphasizes that monetary authorities also are looking at gold with greater interest than they have since the 1960s.

There’s a new reserve currency in town, and it’s yellow and shiny.  What it isn’t is green with pictures of dead presidents on it.  Maybe the Fed’s doubling of M2 the monetary base over the last eight months was a bit…intemperate.

So, the key take-aways here:

1) Higher interest rates possible as auctions fail to find bidders at lower yields.

2)  Billions and billions of dollars floating around, with no place to go but back home.  “Wouldn’t you like to wear $3,000 suits and smoke $75 cigars?  I know I would.”

But, we probably shouldn’t worry. As Glenn Reynolds says, “The country is in the best of hands.”

Knee-capping Recovery

Dale makes an incredibly important point about investment below – investors aren’t going to commit their money to industries which are being manipulated by government for political goals and payoffs.

And, the Wall Street Journal makes a similar argument about corporate taxation and the Obama administration’s apparent plan to compound the problem he hopes to “deincentivize” by driving both investors and US companies off shore..

The energy picture is no rosier. Because there is no comprehensive and clear-cut, long-term energy plan from government, and because it is clear to many that the present administration’s plans for energy involve achieving political goals dictated by government vs. a straight market based plan which would see decentralized signals and decisions determine the energy future, investors are sitting on the sidelines. As Sen. Murkowski said, too many in national government today see the energy sector, and especially the oil and gas industry, as an “ATM to pay for other programs”.

When government is so deeply involved in picking winners and losers, investors are not going to invest. Especially given the example of the car and financial industries.

You can guess what that means in terms of economic recovery, not to mention economic growth. Investment is the engine of economic growth. Without it, nothing sustainable happens. Government can make all the make-work jobs in the world, but until investors commit to the economy, we only mark time economically speaking. If anything government should create a climate that provides incentives for private investors – low taxes, favorable investment rules, etc. to encourage investors to risk their money here in the US.

Instead, we have at least three critical areas where government intrusion and manipulation is having exactly the opposite effect.

~McQ

TARP: The Tragedy Deepens

Michael’s post immediately below deserves to be addressed in some more detail.  Not only is the TARP program pernicious to the banking and financial sector, but it’s implications go much deeper than that, and corrupt the rest of the economy as well.  And most importantly, this is only the beginning.

The corruption expresses itself in a number of ways.  Take a look at the GM/Chrysler situation.  In both cases, the UAW emerge as the clear winners in the bankruptcy proceedings.  In the case of GM, bondholders with $27 billion in bonds are supposed to accept 10% of the company’s equity, while the UAW’s retirement fund, which holds $10 billion in bonds, is supposed to receive 40%, with the Government taking the remainder of the equity. In what possible way is this supportable?

Likewise, in the Chrysler bailout, the UAW will receive 55% of the equity, while Chrysler’s bondholders receive 30 cents on the dollar for their $7 billion investment.

OF course, Chryslers bondholders are balking at this, throwing the compnay into banklruptcy court.  Not that that will save them.  Why?  TARP.  As Thomas Cooley explains:

Chrysler’s dissident lenders have on their side the “absolute priority” bankruptcy rule, which holds that value must be distributed according to the legal priorities of the stakeholders.

Unfortunately, the bankruptcy code also holds that the absolute priority rule can be modified if a two-thirds majority can convince the court that it makes legal or business sense. Two-thirds of the lenders can force the holdouts to go along with them in a procedure called a cram-down.

That is exactly what is likely to happen. Citi, JP Morgan Chase, Goldman Sachs and Morgan Stanley, all major recipients of TARP Funds, all deep in the pocket of the Treasury, agreed to the administration’s plan.

So, the government, holding TARP over the heads of the banks, can now abrogate the generally used bankruptcy rules, and force through a sweetheart deal for a favored political client, the UAW.  But, in so doing, they enlarge the damage to the country’s economy by sounding a warning that government funds are dangerous because the government’s first priority is to re-write the rules to reward their special friends.  The uncertaintly that creates keeps investors on the sidelines.

Many investors are sitting on the sidelines, as is much money. Why? Because it is impossible to know what the rules of the game are. And that’s because the administration and the Congress keep changing the rules in capricious ways in pursuit of larger political objectives.

Megan McArdle make some of the same points, highlighting the danger inherent in such an approach by the government.

Countries that use their banking systems this way don’t get good results.  If you’re a fairly uncorrupt developed country, you get slower growth and bloated “critical” sectors that are usually more critical in providing campaign support, lavishly remunerated make-work jobs, and photo ops, than any products the public actually wants.  Then, if something like Japan happens, you have a twenty-year “lost decade” while everyone pretends as hard as hard can be that everything is all right, in the sincere but misguided believe [sic] that wishing hard enough will make it so.

One wonders if Ms. McArdle now thinks back on her support of Mr. Obama during the last election as “sincere but misguided”.  But I digress.

IN any event, the government has moved full steam ahead with the approach Ms. McArdle decries.  And it will continue to do so. How do we know this?  because of the way the Chrysler bankruptcy is being handled.

I heard repeatedly from progressives, in the run-up to the bankruptcy case, that the holdouts were unreasonably holding out for a trivial improvement–about 500 million dollars.  But if it was so trivial, why didn’t the government just put the extra money in, rather than jeopardizing confidence in the bankruptcy system–and the creditworthiness of a large swathe of unionized firms?  $500 million is about the price of one cup of coffee per American, a trivial sum relative to the overall budget.  This move has shown potential partners that government funds are dangerous, and potential lenders that union firms are risky bets; both have probably cost American citizens more than they saved.  So why did the government risk so much for so little gain?

You know the answer, don’t you?  Because they’re planning to do it again.

And to the extent they keep doing so, and keeping the financial sector in line via the TARP funds, investors will increasingly keep their money out of the game.  Why should they do otherwise?  Any investment in any entity with any relationship to TARP, either directly, or via creditors, is a target for the government to re-write the rules of investment and bondh0lding to ensure their special friends get a nice cut of the action.

True, it’s hard to have much sympathy for either GM or Chrysler.  But the issue now goes far beyond them.  Cooley, again:

There is at least some poetic justice in this outcome. The unions, whose years of work rules, and pension and health care deals helped sink the company, will have to eat their own cooking from now on. But their future success needs not only labor but capital.

Why would private capital get involved when the rules of the game are so capricious? No one would take that gamble when it is clear that, in dealing with the government, private capital will always take a back seat to politically powerful entities.

And that is the larger worry that current policy has neglected. Firms and markets can function quite well within a framework of rules. Indeed, rules are good for the orderly conduct of business. But when rules get imposed or dispensed with willy-nilly in the interests of politics, it is very dangerous. We have should have learned this lesson long ago.

But, apparently, we didn’t.  Don’t worry, though.  I’m fairly certain we’ll re-learn it in due course.

What really offends me the most in all this is not that the government is acting in the interest of favored clients, although that’s extraordinarily offensive.  That’s what governments do.

I think the thing that offends me the most is the sheer stupidity of the thing.