Search This Blog

Tuesday, October 28, 2008

That's Worrisome

Art Laffer, known for the Laffer Curve, predicts The End of Prosperity:

About a year ago Stephen Moore, Peter Tanous and I set about writing a book about our vision for the future entitled "The End of Prosperity." Little did we know then how appropriate its release would be earlier this month.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent. This process is the topic of Nassim Nicholas Taleb's book "Fooled by Randomness."

When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses. [...]

Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street. [...]

Giving more money to people when they fail and taking more money away from people when they work doesn't increase work. And the stock market knows it.

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan's tax cuts, Paul Volcker's sound money, and all the other pro-growth, supply-side policies. [...]

The stock market is obviously no fan of second-term George W. Bush, Nancy Pelosi, Harry Reid, Ben Bernanke, Barack Obama or John McCain, and again for good reasons.

These issues aren't Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren't. [...]

There are many more examples [of disastrous government interventions], but none hold a candle to what's happening right now. Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity.

Laffer is certainly partisan, presents oversimplified concepts, and has been ridiculed extensively. However, his actual predictions over his long career haven't always been all that far off. I hope this is one of his bad predictions, but I do agree that the government has made a big mistake meddling here, so I'm worried.


Harry Eagar said...

Nonsense. By 1932, the Laffer solution -- liquidation of foolish bets -- had been followed to the extent that equities had declined by 89%. There wasn't much room for them to go lower.

However, production did not rise or even stay the same. It kept going down.

And of course the problem, from a social point of view -- I realize that free marketeers value social goods at 0, but bear with me -- is that the people being destroyed are not only or even mostly the people who made the bad bets.

Bret said...


I think you must've missed the "if left alone" phrase in "Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production."

The economy wasn't left alone before and during the great depression. Smoot-Hawley, raised income taxes, etc. were all government meddlings.

Again, I hope you're right and Laffer is wrong in this case.

Harry Eagar said...

That's true but irrelevant. High tariffs did not cause the speculation on Wall Street.

And the farm economy was left alone, and it did crash. And it continued to be left alone, until Roosevelt tried to aid it. His attempts were declared unconstitutional, so nothing continued to be done, and it didn't recover.

Unsupervised markets always crash.

But if you want to offer an example of an unsupervised market that failed to crash, I'm all ears.

Bret said...

harry eagar wrote: "But if you want to offer an example of an unsupervised market that failed to crash..."

iPods, computers, light bulbs, microwave ovens, dishwashers, ...

Harry Eagar said...

Those would be products not markets.

Nobody securitizes loans for microwave ovens or sells futures on iPods or hedges dishwashers.

But if they did, you can be sure they'd crash.

If you would like an example of a totally unsupervised, unregulated market, uninterfered with by government, I suggest the US stock/financial markets in the 1870s.

The crash of '73 -- contra Laffer -- did result in decreased production and employment, and the recovery didn't begin for 7 years.

And after that, the recovery was not to a free market, as you will recall if you have studied your US economic history.

Quick class: what sort of financial/market system did the (still totally unregulated) US economic system develop in the '80s?

Why, yes, cartels.

Anonymous said...

I am still waiting for you to provide a specific example of why a free market based cartel was bad.

I am also far more sanguine about crashes. One solution, after all, to never falling is to never rise. I am still trying to picture the Eagar Economic System where growth is regulated and failing industries gently expired so as to prevent crashes yet not captured by government regulation based cartels.

P.S. I will skip over the fact that we fundamentally disagree about whether government regulated markets crash, because I think the current crisis is an archetypical example of such, while Mr. Eagar insists on total absolution of any government fault.

Harry Eagar said...

I am not absolving the government, which has been thoroughly incompetent. But overregulation was not its error.

I cannot get my mind around the concept of free market cartel. Cartels restrict markets.

The very mild restrictions on financial markets did not limit growth during the six decades these were in effect. In fact, these were the most prosperous decades Americans have ever experienced.

Not all that can be attributed to adult supervision. A good part was thanks to the destruction of World War II, which left the US with half the world's industrial capacity up through the mid-'50s.

Plenty of ill-run businesses failed during the period, including Packard, Polaroid and (for all practical purposes) Xerox.

Bret said...

harry eagar wrote: "...the government, which has been thoroughly incompetent. But overregulation was not its error."

The government has been incompetent.

I've got a good idea! Let's put the incompetent government in charge of more regulation! Yeah, that's the ticket!

Harry Eagar said...

If we replaced the mystics with reality-based officials, the results would be different.

So history suggests, anyhow.

Or, as Mahan Atma (whoever he is) said, 'Faith-based accounting doesn't work.'

Bret said...

How does history suggest that the results could be different?

Anonymous said...

Mr. Eagar;

You said this crash was "a pure market failure". Is that statement now inoperative?

I am also curious as to where you are going to get reality based regulators. I can overmatch your GOP selections with the Reid/Pelosi/Frank/Dodd crew. That leaves ...?

Harry Eagar said...

We had successful regulators from 1936 until sometime in the mid-'90s.

The lack of later success could be attributed to the inevitable sclerosis of all institutions, or to the fact that people who believed in the institutions were replaced with people who didn't, which might perhaps affect performance.

It was a pure market failure. I had a conversation today with our local director of muncipal finance. Both she and I were surprised and appalled to learn that other jurisdictions have been selling general obligation and revenue bonds tied to credit default swaps, at the instigation of the lender with no recourse to the borrower.

In this state, that didn't happen, because it's controlled by Democrats, and they New Dealishly passed a law -- those scoundrels! -- forbidding public funds to be involved with derivatives.

Depending upon how Republican your local bonding authority was, you may fairly soon be asked to pay a whole lot more for government services.

If that isn't a free market failure, I don't know what could be. It wasn't mandated by the CRA.

Anonymous said...

So you're not absolving government agency, just saying that absolutely no blame attaches to it. I see.

You go with Hawaii, I'll go with Illinois, a state run by a heavy Democratic Party that's created a massive pension disaster without using derivatives at all. But I am sure that somehow, that's a pure market failure as well.

Hey Skipper said...

It was a pure market failure.

Hypothetical: what if Congress had passed a law in 1995 forbidding mortgages supported by less than 10% of the loan amount?