By John Tamny
“The federal government is the only entity left with the resources to jolt our economy back to life.” – President Barack Obama, Confidence Men, p. 186
It’s often been said in various ways by economic thinkers of the classical school that booms and bull markets don’t die of old age, rather they succumb to policy failure. Economies, and by extension stock markets, in this certain sense do best when policy barriers to productive economic activity are light.
But with policy from fallible politicians ever present irrespective of political party affiliation, mistakes are inevitable. And because they are, the stock markets thankfully exist so that investors can cast ballots on decisions emanating from Washington.
It’s said that news about President Hoover’s future intent to sign the Smoot-Hawley tariff over 80 years ago sent stocks cascading downward, and then in 1987 stocks were similarly spooked when a combination of tariff threats with Treasury Secretary James Baker’s ill-fated comments about dollar gave investors yet another shock on the way to a 22% market plunge. Policy matters, and as investors are tautologically buying future dollar income streams, a comment by a Treasury official seeking a weaker greenback logically scared many investors to the sidelines.
The role of economic policy as it applies to the direction of stock markets bears renewed mention given the views of our current president, and our understanding of the state of the stock market. From them investors can hopefully divine a better sense of how the markets will perform owing to greater knowledge of the kind of policy that might emanate from Washington.
Up front, it’s hard to be terribly optimistic about future vibrant markets of the Reagan 1980s and Clinton 1990s variety. As the quote leading this article makes very plain, President Obama sees the government as the main source of growth given his presumption that it alone at present has the resources to nurse our economy back to health.
Of course what’s perhaps missed by a President whom former Fed Chairman Paul Volcker once described as “too self-confident” is that governments don’t have resources. Their resources consist of their ability to tax or borrow always limited resources from the private sector in order to engage in forms of economic intervention.
The problem here is that to the extent that governments tax in order to spend, they’re by definition raising the price placed on productive work. Taxes are a certain cost barrier foisted on economic activity, and then when governments borrow money in order to spend, they’re necessarily extracting limited capital from the private sector that might otherwise fund future wealth creation over near-term capital consumption by the political class. Stock market indices render judgment on the quality of companies within, along with their future prospects, and if the price of work and capital is being increased through taxation and borrowing, this on the margin will weigh negatively on stock market health.
It’s also been uttered over time that “personnel is policy”, and the individuals Obama has surrounded himself with in order to advise on economic policy require prominent mention. Looking back to April of 2009, seeking ideas on how the government could lift economic spirits, the President didn’t bring in a mix of economic viewpoints, rather he called to the White House Joseph Stiglitz, Paul Krugman, Jeffrey Sachs and Kenneth Rogoff.
So as opposed to a spirited debate among economic thinkers about how to best get the economy moving again, those in attendance encouraged even more government spending; Stiglitz calling for $2 trillion. Though the President would have been advantaged by contrarian views, it’s apparent that early in his presidency he surrounded himself with thinkers eager to confirm what he’d already concluded.
Considering the economists working under President Obama within the White House, upon accepting the President’s offer to head up his Council of Economic Advisers, it’s been reported that Christina Romer had “Rooseveltian fantasies dancing in her head.” Though it’s accepted logic in some quarters that President Roosevelt somehow saved the United States from certain desperation with his New Deal, saner minds might point out that the first nine years of his Presidency amounted to a great deal of economic hardship followed by the horrors of war and the relative economic autarky that came with the last four years of Roosevelt’s time in office. Far from an era of economic renewal, the Roosevelt years were characterized by a great deal of economic pain, thus raising the question of why Romer would want to promote policies that would give Americans a repeat of a not so grand period in our history.
In the same meeting, Obama casually observed to Romer that “It’s clear monetary policy has shot its wad.” Romer’s scary response, which perhaps foretold the Administration’s endorsement of the Fed’s quantitative easing policies that have weighed heavily on the dollar was, “No, you’re wrong. There’s quite a bit we can still do monetarily, even with historically low interest rates.” This is important to consider in light of what investors in the stock market are once again buying: future dollar income streams.
Returning to stimulus spending, once the initial $787 billion bill failed to reduce unemployment (quite the opposite as classical theory would suggest), rather than admit to what hadn’t worked, the economists Obama surrounded himself acted as though the initial amount hadn’t been enough. Orszag called for $700 billion in new spending while allowing for the political difficulties of achieving such a number, then Romer weighed in that even $100 billion, at $100,000 per job, would be the correct move. In her words, “A million people is a lot of people.” You can’t make this up!
President Obama, sensing the political difficultly of more government spending, instead offered up the opinion that “high unemployment was due to productivity gains in the economy.” Seemingly lost on the President is that there are no jobs without investment, and investors as a rule are attracted to the kind of productivity the President decried.
Happily in a small sense, National Economic Council Chair Lawrence Summers disagreed with the President’s analysis, as did Romer, though their analysis was equally deficient. Romer observed that “What was driving unemployment was clearly deficient aggregate demand.” Not mentioned by Summers, Romer or anyone near Obama is that in order to stimulate demand one must stimulate the supply side of the economy; as in remove barriers to economic activity erected by Obama and his White House predecessor. The reality that production is what drives demand has had no voice in the Obama White House.
Classical economic theory tells us that there are four main barriers to economic activity; as in the production that drives the aggregate demand that Summers and Romer pined for. First up are taxes. Taxes as mentioned earlier are a price placed on work, so the lower the cost of productive work effort, the more work that reveals itself. Regulations by nature inhibit productive economic activity with little positive effect (figure banking remains one of the most heavily regulated sectors with no positive impact as evidenced by 2008), and then trade restrictions retard the natural expansion of the division of labor that stimulates production, plus the restrictions/tariffs themselves invariably subsidize weak industries at the expense of the strong ones necessarily hurt by trade barriers.
Looked at in light of the Obama administration’s economic policies, if re-elected Obama will allow the abolishment of the 2003 Bush tax cuts (arguably the lone positive economic development of Bush’s hopeless Presidency), regulations on finance, healthcare and energy have already gone skyward, and then by all measures, trade has become less free since 2009. With stock markets serving as a future-discounting barometer of our economic health, the Obama administration’s unfortunate policy decisions in these three areas help explain a stock market that is flat over the past year, and would on their own would point to difficult economic/market times ahead.
Of course left out in the above is the fourth economic input; specifically stable money values. Stable money is easily the most important of the four to economic health, yet here the Obama Treasury is failing most impressively, as the Bush Treasury similarly did with its own support for a weak dollar, and its failures point to listless markets in the future no matter the direction of the other three.
To understand why, it’s essential to reference a recent New York Post article which revealed that over the last 10 years the S&P 500 Index had risen 7 percent versus a 479 percent rise in the price of gold. This glaring disparity should horrify investors.
Figure that gold has highly limited industrial uses, yet over the last ten years an investor would have achieved exponentially better returns for having committed all available capital to gold over some of the most promising companies in the United States.
Looked at in this light, is it any surprise that job creation remains sluggish, not to mention the fact that Americans have for the most part experienced one of the more difficult decades on record in terms of economic growth?
A rise in the price of gold tautologically signals a decline in the value of the dollar. From an investment perspective, when those with capital commit it to new ideas their explicit hope is that some time in the future they’ll achieve returns on funds invested greater than what they initially committed.
Of course the problem with currency devaluation of any kind is that assuming returns on monies invested, those gains will come back in cheapened dollars. Though many economists and commentators wax poetically about the wonders of competitive devaluations, simple logic tells us they dampen growth. The latter is largely driven by investment in productive concepts, yet devaluation removes the incentive for intrepid investors to offer up capital to those same concepts.
Importantly, investors don’t simply disappear during periods of monetary mismanagement, rather they reorient their investing styles. Instead of providing capital to future-oriented concepts that would in some instances enhance our productivity, and boost stock market indices, there’s a greater incentive to move their dollars into inflation hedges that will protect them from the devaluation.
Economic historian Brian Domitrovic described all of this very well in his 2009 book, Econoclasts. As he put it so clearly then about what occurred during the similarly devaluationist decade of the 1970s, “As for future stuff, it cannot be produced without investments in financial assets. The shift into tangibles thus prefigured a decline in production.”
Perhaps put more simply, when the value of money is in decline, investment on the margin flows into hard assets – think gold, land, art, and rare stamps – that already exist, and it flows away from the stock and bond investments that will foster the creation of the wealth which doesn’t yet exist. Devaluation is in this certain sense a blast to the past as investment in tomorrow’s ideas is no longer as plentiful.
And then happily for the purposes of this piece, we can compare stock market returns in the ‘70s and over the last ten years to the returns achieved in the ‘80s and ‘90s when gold weakened. The results are pretty striking.
In the 1980s the price of gold fell 52 percent, and the S&P rose 222%. Fast forward to the 1990s, gold’s descent continued on the way to a 29% decline which occurred in concert with a 314% increase for the S&P. As mentioned earlier, Investors are buying future dollar income streams when they put capital to work, so rising stock markets logically coincide with periods when the dollar is similarly strong.
Considering the Obama stock market, the price of gold since 2009 has more than doubled, which means the value of the dollar has declined. At present there’s no evidence that the Obama Treasury or the Administration have changed their tune on dollar policy, which tells us that continued dollar weakness will coincide with stock market returns that leave much to be desired. Putting it plainly, the Obama administration is violating the four basics (taxes, regulations, trade restrictions, dollar policy) that always coincide with economic and market health when they’re moving in the right direction, and stock prices will continue to reflect these policy errors.
More broadly, it’s very clear that far from believers in the fundamental ability of economic actors to create prosperity through rational, unfettered self interest, Obama et al believe that the federal government should have a very relevant role in boosting our economic spirits. Given the bad track record among governments when it comes to creating prosperity, it should then be said that assuming an Obama victory in 2012, stocks will only rally after to the extent that investors price in political barriers that will block the President’s desires. In short, the outlook for stocks going forward isn’t good, and they’ll only rally to the extent that the President fails legislatively. (my emphasis)
By John Tamny for Real Clear Markets
By permission John Tamny
John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com).