Ruminations, December 30, 2012
Trickle down economics
***Keynesian politicians typically use the phrase “trickle down” to refer to supply-side economics. The basic tenet of supply-side economics holds that economic growth is best achieved if barriers to work and investment (taxes) are reduced. This tax reduction includes reductions for the country’s top earners who do most of the investing. Using the “trickle-down” term whenever a tax reduction is granted to the top earners implies that the middle and lower economic classes will gain a smaller share of the financial windfall – as the wealth trickles down. Although it is impossible to measure with any certitude, in general there is some truth to the statement. (It is, by the way, a lot more delicate than Franklin D. Roosevelt’s terminology -- “leak down.”)
But have you noticed that anti-supply-siders drop use of the phrase “trickle down” when it comes to higher taxes on top earners? It stands to reason that if tax cuts trickle down, then so will tax increases. A prominent example occurred during the presidency of Jimmy Carter. Carter promoted a luxury tax on yachts to raise tax revenues and to make the wealthy pay a larger share of taxes. That tax immediately affected wealthy yacht buyers (who stopped buying) and then trickled down to yacht construction workers with a loss of an estimated 20,000 yacht-building jobs.
Now some might say that the loss of jobs was structural: Carter’s tax was good and the ship builders would find new jobs – eventually. That argument may have some substance during boom times, but during periods of high unemployment, finding a comparable new job and acquiring the necessary skills for it are not easy.
The basic point is that we are all in this together and if we cut taxes on the top earners, the benefits will trickle down to us. If we tax the top earners more heavily, those taxes will also trickle down to the rest of us. It’s your choice.
Bernanke’s monetary policies are starting to hurt
Whatever rhetorical subterfuges Ben Bernanke has used during his tenure as Federal Reserve chief (quantitative easing, operation twist, mortgage-backed securities), it has been apparent that the Fed has been printing money. Had most any other nation tried this it would have financially failed but, given the historical strength of the U.S. dollar and the perceived sagacity of the Federal Reserve chieftains, the world has persistently supported the Fed’s policies – even to the point of ignoring two credit downgrades in the past year.
Bernanke has been helped by the facts that the European Monetary Union (EMU) has problems of its own and in tandem the EMU and the U.S. Fed have provided a veneer of competence and wisdom to the international monetary scene. They had hoped, one surmises, that their extraordinary machinations would allow them some time to fix the economic problems and then to rectify their unfortunate monetary policies.
Things have started to change. Last year, Brazil claimed that the Fed’s policies have caused an increase of buyers to the Brazilian capital markets and were also causing an economic real estate bubble (similar to the U.S. real estate bubble that burst in 2007-2008). This also contributed to a strengthening of the Brazilian real. A stronger real means that Brazilian exports will be more expensive, and Brazil has threatened to retaliate by devaluing its currency.
Even with the euro and the dollar working together and China tied to the dollar, there have been problems with other currencies. Last week Japan’s new Prime Minister, Shinzo Abe, complained that dollar and euro (and by implication, the Chinese renminbi) have weakened, causing the Japanese yen to rise in value. This has hurt Japanese exports and Abe has said that he will pressure the Bank of Japan to weaken the yen.
Whoa! If Japan and Brazil are complaining about the dollar and euro and threaten to weaken their own currencies, could this portend a currency war where more and more countries devalue their currencies? Yup, it could.
Well, what’s so bad about a currency devaluation war? Plenty. For starters, international trade will slow, hurting all countries. The predictability of currency valuations disappears and interest rates begin to rise (interest on U.S. debt in 2012 was almost $360 billion) increasing our debt -- as international trade drops. It makes borrowing (that’s how we finance our debt today) more problematical. A currency war can contribute to commodity bubbles (e.g., real estate, oil, gold, copper, etc.) and inflation.
Does Bernanke know all this? Sure he does. He’s a smart cookie. Is he smart enough to avoid a currency war? One way of looking at it is that he has already begun a currency war and how much it escalates depends on the other countries and whether they choose to play. If other countries do choose to play, can Bernanke avoid escalation? If the other countries are sufficiently small and few, he can. Otherwise, given his commitment to his policies and President Obama’s endorsement of his policies, he is probably a player.
What can we do? Hope and pray that Bernanke begins to mitigate his policies toward a stronger dollar or that he chooses not to stay on as Fed Chairman and President Obama appoints a new chairman who has different policies. Other than that, we’re as stuck as Bernanke.
Quote without comment
Paul Volcker, former Federal Reserve Chairman and former Chairman of President Obama’s Economic Recovery Advisory board, speaking at a conference of Chartered Accountants in Gleneagles, Scotland, September 22, 2012:”Europe is in or near recession, including the UK. So don’t look to the UK, to China, Brazil or India — the US is the only country that can create the type of economic hope and market leadership the world needs. We have a weaker platform than we used to but it is still the most important platform in the world.”