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What we saw in October was an old fashioned Panic. A couple of generations ago, schoolchildren learned about them in history class. The US had Panics in 1819, 1837, 1857, 1873, and 1893 resulting from real estate bubbles. And Panics in 1884, 1907 and 1932 due to bubbles in other asset classes.

Bubble cause Panics. No amount of regulation can stop bubbles from happening. It's not like they didn't try. After the bubble of 1720 derivatives and short selling were actually banned for decades (yes they had derivatives nearly four centuries ago--there is no true innovation in finance; the same old stuff gets recycled with new names.)

The British authorities tried strictly regulating money creation by the British Central Bank in 1845. Didn't stop the bubble and subsequent panic in 1847. America opted for a central bank after the 1907 Panic, but that didn't work all that well after 1929.

As long as income inequality is high, the rich will have the wherewithal to bid up asset prices to a point where a bubble can form. For nearly half a century after WW II, high taxes in the US kept income inequality too small to achieve the sort of sustained bull market needed to ignite a bubble.

It wasn't until the great boom of the 1990's that the rich finally had enough funds to bid up stocks to the highest levels ever seen and then some, an event that showed how "it was different this time". Only then did an old fashioned bubble develop in stocks. This bubble had official sanction by the passage of the 1997 capital gains tax cut which was intended to produce capital gains from a stock market that was already overvalued.

This bubble was deflated without event by aggressive Fed action that encouraged funds fleeing the stock market to go into real estate. And then in 2003, the government sanctioned another bubble by passing another decrease in capital gains taxes intended to stimulate capital gains in an overvalued real estate market.

This time the Fed was unable to deflate the bubble safely and so we got a Panic. Once again, central banks cannot stop these things, not in 1847, not in 1929 and not today.

Now if we end up with a full-scale Depression, it will take a long time to "recharge" and we won't have another Panic for maybe 20 years. If we manage to avoid a Depression, then we will be right back here within 10 years, unless taxes on the rich are raised worldwide to "drain the swamp" of cash available for asset purchase (i.e. investment).

It's really as simple as that. You can run a high tax, Panic-free economy like we did over 1945-1981 with the problems attendant to that, or you can continue the low-tax policy in place since 1981 and get periodic Panics.

There really is no free lunch. Each type of policy has its drawbacks. What we are going through now is one of the drawbacks of the low-tax economic policy.

Originally posted to Mikebert on Tue Dec 02, 2008 at 04:18 PM PST.

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Comment Preferences

  •  I recommended and tipped (0+ / 0-)

    because I disagree and want the discussion to live a while: exhibit #1

    Balanced budgets and depressions
    American Journal of Economics and Sociology, The,  April, 1996  by Frederick C. Thayer

    Since 1791, the earliest data available, the national debt has been increased in 112 years, decreased in 93 years. 57 of those balanced-budget, debt-reduction years have been concentrated in six sustained periods of varying length. Also since 1791, there have been six significant economic depressions among the innumerable "business cycles." Each sustained period of budget-balancing was immediately followed by a significant depression. There are as yet no exceptions to this historical pattern.

    This is the record of six depressions:

    1. 1817-21: in five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.
    1. 1823-36: in 14 years, the debt was reduced by 99.7 percent, to $38,000. A depression began in 1837.
    1. 1852-57: in six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857.
    1. 1867-73: in seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.
    1. 1880-93: in 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.
    1. 1920-30: in 11 years, the debt was reduced by 36 percent, to $16.2 billion. A depression began in 1929.

    There has been no sustained period of budget-balancing since 1920-30, and no new depression, the longest such period in our history.

    The question is whether this consistent pattern of balance the budget-reduce the national debt-have a big depression is anything other than a set of coincidences. According to economic myths, none of these sequences should have occurred at all. How on earth, for example, could we virtually wipe out the national debt in the mid-1830s, then fall immediately into one of the six recognized collapses in our history? Those who write about the desirability of reducing the national debt frequently praise Andrew Jackson for his vigorous pursuit of such a goal, but do not mention "depression" in the same breath. It is helpful to the maintenance of economic myth to say little about depressions in textbooks, thus making it easy to avoid looking at connections considered impossible anyway.

    The mutual finger-pointing now underway is aimed at the 1996 elections, Democrats and Republicans each blaming the other for the agreed disaster of high deficits and debt. Yet the deficits of the 1930s and recent years were trivial, relative to GNP, when compared with the wartime deficits of the 1940s that ended the Great Depression. Federal deficits in World War II ranged from 20 to 31 percent of Gross National Product. For a few years, the national debt was greater than GNP, the only such period in U.S. history.

    The national debt is now less than 70 percent of Gross National Product (GNP), much below the 130 percent debt of the late 1940s, and a debt that remained higher than today's debt until the mid-1950s. According to economic myths, that wartime spending should have made things worse, not better.

    Those who look closely, therefore, will see some obvious intellectual dishonesty at work. It is dishonest to avoid looking at depressions and wars when discussing the evils of deficits and debt, and to propagandize by using absolute levels of deficits and debt when only relative comparisons are valid. It is dishonest to write textbooks in which there is no mention of what Herbert Hoover, Franklin Roosevelt, and noted financier, Bernard Baruch, had to say in the early 1930s about causes of the Great Depression. The belief at that time, even if rejected by economists, was that "overproduction," "excessive" and "destructive" competition were to blame. To be sure, nobody has suggested that government underspending can massively contribute to big depressions, even though this is only the flip side of overproduction. Put another way, if the market for consumer goods cannot do the job, there is every reason to turn to the production of public goods, always in short supply anyway.

    The tragicomedy of economics is easily displayed. If someone borrows money to build a brewery, the money is officially listed as "investment" in national income accounts. If government borrows money to build a bridge that is needed by the brewery, these funds are not listed as "investment" because the bridge is considered "waste." To think that this sort of logic undergirds public policy is to experience pure fright. Economics, of course, is not the only "discipline" that fills the world with unsupportable myth, but it is among the leaders.

    [Frederick C. Thayer is a Visiting Professor of Public Administration, George Washington University, Washington, DC 20036 and Professor Emeritus, Public and International Affairs, University of Pittsburgh.]

    COPYRIGHT 1996 American Journal of Economics and Sociology, Inc.
    COPYRIGHT 2004 Gale Group

    "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

    by johnmorris on Tue Dec 02, 2008 at 04:52:52 PM PST

    •  This is a rather naive view (0+ / 0-)

      The US sought to maintain price stability during the 19th century.  After wars bid up prices, the government ran surpluses to create deflation to drive prices back down.  As a result, a dollar was worth about the same in 1932 as it had in 1800.

      So when the country was at peace, the government ran surpluses during good times and deficits during depressions, which is the pattern shown.  This is simply an necessary outcome of policy of maintaining price stability.

      The take home lesson here is that trying to achieve true price stability risks depressions.  This is generally accepted and so the goal of Fed policy is low (but not zero) inflation.  

      As we can see now, financial crises can happen even if the government has been running deficits and there has been regular inflation. Since financial crisis is what I am talking about, I don't see how this article is relevant.

      •  Why don't (0+ / 0-)

        you try to justify that view with something beyond waving your hands at it. Dr. Thayer contends that government sequestering money by balancing the budget is an economic disincentive. You say that the resulting depressions & recessions were a conscious policy goal. Do you have some evidence? Because I know of no one who has admitted that. Volcker caused a recession and said it was on purpose to stop inflation but he didn't do it with a budget surplus, he did it with a 20% interest rate. The budget balancers all tell us what a good idea it is. Now you insist that, even if it causes recessions, we mean to do that. Why don't you find someone else who agrees?

        "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

        by johnmorris on Tue Dec 02, 2008 at 09:40:21 PM PST

        [ Parent ]

        •  You are confusing the issue (0+ / 0-)

          The data you presented were from the pre-New Deal era.  During that time the business cycle was believed to be a natural rhythm of ecoomic development.  Also, before the New Deal, there were no "recessions", economic downturns were called depressions.  After the 1930's the word depression got a bad connotation and the word recession was substituted for it.

          At no time have we "planned" to have recessions and depressions.  I never said that.

          What I said was before the New Deal we planned to have price stability.  Since wars happen, we get deficit spending for them and inflation.  So if your goal is to have zero inflation, and you have deficits and inflation during wars, that necessarily means that you are going to have to run surpluses to get deflation during peacetime.

          There was no interest rate policy at this time, the gold standard handled that automatically.

          So yes, during peacetime the US tried to run surpluses before the New Deal.  Obviously when there was a depression tax receipts fall and the government did not generate a surplus.

          Thus the peace time budget is going to show a string of surpluses, ocassionally broken by strings of deficits associated with periodic naturally-occurring depressions.  This is exactly what the data show.

          That data is NO evidence at all for an effect of balanced budgets on depressions.  To say that it is is naive.


          •  Virtually every word of that (0+ / 0-)

            is nonsense. Thayer wrote that in 1996, not pre new deal, and the reason that there were no data at the time was that there had been neither a balanced budget nor a deep recession. Both Eisenhower and Nixon strove for balanced budgets, stimulated minor recessions and primed the pump again. Four years after that essay Clinton balanced the budget and handed Bush a recession which was solved with cheap credit leading to a bank failure. The gold standard, in the USA, survived to 1973 when Nixon floated the dollar repudiating the Bretton Woods agreement. The bureaucratic forcing of the basic interest rate was invented by the Bank of England in the mid 19th century and some, outlying economists, attribute the crashes of the late 1800s's to the bank's defense of the gold standard, That was certainly the position of the bimettalists, it was the subject of William Jennings Bryan's "Cross of Gold" speech and of the Wizard of Oz books and was one of the serious fights in American history. Here's a little Keynes: the government is the largest conscious player in the economy and it has, in a democracy, a duty to care for the people. Luckily, taxing money away from rich people and spending on people in general is good for economic growth. Any mechanism that sequesters money, including balanced Federal budgets and savings by rich people, discourages growth. The historical demonstration of that principle is the inexorable succession of balanced budgets and recessions.

            "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

            by johnmorris on Wed Dec 03, 2008 at 05:47:41 PM PST

            [ Parent ]

            •  reply (0+ / 0-)

              Thayer wrote in 1996, the data you posted was from before the New Deal.  Truman, Eisenhower, Kennedy, and Johnson all strove for balanced budgets in peacetime and achieved them.  This was also the time of the postwar boom.  THe boom was NOT made possible by fiscal stimulation.

              Recessions happen.  They happened in the 1970's and 1980 when the governmetn ran deficits and they happened in the 1950's and 1960's when they did not.

              The gold standed ended in 1933.  In the Bretton woods era the world ran on an offical dollar standard.  Other nation's currencies could be exchanged for dollars at a fixed exchange rate set by that nation.  Suince the US ran hefty trade surpluses it always had large supplies of foreign currencies.  You could always exchange dollars for your own currency.  Gold never changed hands.

              However in 1971, the US no longer had adequate supplies of foreign currencies for exchange for dollars.  And when the French asked that gold be exchanged instead (as was theoretically possible) Nixon didn't give it to them. So no, there was no gold standard.

              The rest of your post is correct.  The problem was the gold standard, which led to deflation.  The surpluses were simply the means by which deflation was produced.  It is the deflation that is the bad actor, not the surpluses.

              Hence, after WWII, when we no longer had deflation in peacetime, we ran balanced budgets and got prosperity.

              Taxing rich people and spending on people in general is a balanced budget.  Deficit spending is borrowing money from rich people and spending on people.  Borrowing means more interest payments to rich people in the future.  I don't see why you advocate this.

  •  Exhibit #2 (0+ / 0-)

    "For nearly half a century after WW II, high taxes in the US kept income inequality too small to achieve the sort of sustained bull market needed to ignite a bubble."

    Done and done again. From the beginning of the Republic it has been the case that there are two political parties. One for the Farmers, craftsmen and laborers and one for the business interests. When the businessmen are in power, they break the economy and the Army. When the people are in power they save the nation. The ratio has run roughly 50/50.

    "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

    by johnmorris on Tue Dec 02, 2008 at 05:06:19 PM PST

    •  The achievement after WW II was unique (0+ / 0-)

      Before the New Deal real GDP per worker rose at an average rate of 1.5%.  Since 1981 the same 1.5% growth rate has been achieved.  The period between the New Deal and 1981 saw growth at 2.3%--50% faster.

      One thing different about this postwar period was that real interest rates during expansions were much lower than the levels seen in both the pre-New Deal and post-1981 periods.  Since low interest rates are known to be stimulatory, this can explain the faster growth then.  What was special was that these low rates were used without triggering high levels of inflation (until the 1970's).

      What kept inflation at bay and so allowed such a "supercharged" economy to be run?  Balanced budgets were part of it; when deficits first appeared, inflation did also.  I propose that the high taxes that prevented investment bubbles also served an inflation suppressing function.

      That is, not only do high taxes prevent bubbles and financial crises, but they also permit faster economic growth.


      •  Low interest rates (0+ / 0-)

        Are assumed by conservatives to be stimulative. This period is all the proof they have. How about this, high tax rates on the wealthy are stimulative because the accumulation of wealth sequesters money. That's both a result and a mechanism. You'd have to demonstrate that low taxes stimulate. what, investment, spending, what? Clearly, reducing capital gains taxes has never stimulated investments. Reducing income taxes has never been shown to increase spending. Actually, since 1928 there have been 40 years of Republicans and 40 years of Democratic Presidency's. The primary difference has been that the Democrats have taxed rich people at higher rates and the out put has been that growth rates under Democrats have been roughly, as you cite, twice as high as under Republicans. As a monetarist, you'd like to attribute this to interest rates but its unique to high tax periods and in all of those, spending was in deficit. Balanced budgets are poison.

        "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

        by johnmorris on Tue Dec 02, 2008 at 10:01:30 PM PST

        [ Parent ]

        •  reply (0+ / 0-)

          During the 1946-1970 period, when growth was fast and taxes were high, the budget was balanced during peacetime.

          We had a sizable deficit in 1968 because of the Vietnam war.  Johnson put through a tax increase and the defict was wiped out in 1969, despite a raging war.  So fiscal restraint remained in place from the end of WW II until 1970.

          Then came the deficit-loving Republicans Nixon and Ford, the later who ran the highest peacetime deficit in history up to that time.  Carter came in and slashed the deficit.  He also appointed Volcker and gave him the mandate to crush inflation.  He did and Carter lost the election.  Had he been re-elected, the deficit would have been vanquished by the end of his second term; the country would not have expereinced the degree of deindustralization forced by the high interest rates and strong dollar of the 1980's (both the result of Reagan-Bush deficits).  We could have gotten another Democratic Fed chief in 1986 instead of that Randian Alan Greenspan.

          Instead we got two more deficit-loving Republicans in office who broke Ford's record for peacetime deficits.  (And to add insult to injury we got the odious Alan Greenspan).  Clinton comes in and finishes what Carter tried to do (he got two terms and so was able to do it).  Then Bush comes in and we are back to Republican deficits.

          Now I do NOT advocate that Obama worry about the deficit.  I am sick of Democrats fixing things so the Republicans can waltz in and fuck things up again.   He should deal with the crisis and use it to pass his agenda (health care, green jobs and education).  But after he does that he should use the deficit as an excuse to hike taxes on the rich through the roof and to slash the military.
          I believe you and I agree that we should raise taxes.  But your mechanism is simply wrong.  When the government runs a surplus it's not "sequestering" the money.  It goes to pay down debt, that is, right back into the economy.

          In the linked article I showed that lower taxes on investment DO stimulate most kinds of investment--just not the kind that generates jobs.  This type of investment reflects interest rates (low interest rates stimulate job-creating investment).  

          A good example of how low taxes stimulate non-job-creating investment consider capital gains taxes. They were cut in 1997 and in 2003 and what happened immediately afterward?  Huge increases in capital gains in stocks (after 1997) and in real estate (after 2003) creating enormous asset bubbles.  The collapse of the second of these bubbles has caused our current financial crisis.  Thus we can say that the financial crisis was directly produced by the stimulation of investment caused by tax cuts in 1997 and 2003.  There can be no better example of how tax cuts can stimulate "malinvestment" which was the principal cause of the pre-New Deal depressions.

          Do you think that two "once in a century" bubbles just three years apart "just happened"?  You don't think that the fact that tax changes intended to produce rising asset prices that happened just before the rising asset prices of the bubbles is just a coincidence?  You don't think those tax cuts worked to push stock and housing prices up?  Is this what you are arguing?

          •  Wha? (0+ / 0-)

            >During the 1946-1970 period, when growth was fast and taxes were high, the budget was balanced during peacetime.<<br>Twice, both by Eisenhower, both causing short recessions the congress threw money at.

            >Carter came in and slashed the deficit.  He also appointed Volcker and gave him the mandate to crush inflation.<</p>

            I'll bet you weren't trying to live on wages through that one. It was a doozy.

            >You don't think that the fact that tax changes intended to produce rising asset prices that happened just before the rising asset prices of the bubbles is just a coincidence?  You don't think those tax cuts worked to push stock and housing prices up?  Is this what you are arguing?<</p>

            Frankly, no. I think the relentless deregulation of financial markets and Allen Greenspan's maintenance of artificially low interest rates encouraged successive bubbles in first high tech, then housing and, as that burst, in commodities causing our current mess.

            "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

            by johnmorris on Wed Dec 03, 2008 at 06:10:58 PM PST

            [ Parent ]

            •  Huh? (0+ / 0-)

              Here's a graph of deficits/surpluses as a % of GDP.

              You can see then huge WW II deficits in the 1940's.  You can see a blip of surplus as tax caused by demobilization and continuation of high FDR's policy of high tax rates on the rich.  Then from about 1950 to 1974 the budget was essentially balanced.  This 24 year period saw the best sustained growth in our nation's history.

              How did deregulation produce the stock market bubble?  Margin levels did not change.  Explain how regulation changes made people buy stock in worthless companies like, or drive the NASDAQ to 5000?

              •  The repeal of (0+ / 0-)

                the Glass Steagall act, in 1999, allowed financial companies to merge and commercial banks to issue bonds and broker stock offerings. The resulting glut of Initial Public Offerings was the fundamental cause of the stock explosion. Prior to that, several tiers of deregulation had stimulated the same kind of minor speculative bubbles through the 90's. Greenspan's championing of the bond market led Clinton and Rubin to lean toward stocks for stimulus. People buy what's offered, worthless or not.

                "If I pay a man enough money to buy my car, he'll buy my car." Henry Ford

                by johnmorris on Fri Dec 05, 2008 at 09:21:06 PM PST

                [ Parent ]

                •  New issues (0+ / 0-)

                  do not make the prices of established stocks rise.  An IPO craze can cause excessive bullishness in specific market sectors like the 1983 PC boom, the late 1950's 'tronic boom, or the late 1960's "go-go" era.  The larger market is unaffected.  

                  This is not what happened in the late 1990's.  The term "tech wreck" is a misnomer used to obscure what really happened.  By the end of the 1990's GE's multiple rise to the ridiculous level of 50!  Fifty times earnings for 118 year old company.  The P/E on the S&P500 reached 30! by the end of the 1990's.  There were no regulations before the New Deal and stocks never got remotely as overvalued as they did in the 1990's.  The market P/E at the 1929 peak was 20, that in 1987 was about 22.  Thirty P/E at a market peak is unprecedented, but then so is a capital gains tax cut in the face of a market P/E over 20.  

                  New IPOs cannot make stocks of established companies rise.  How does deregulation cause ordinary people to buy stock in established companies like GE, Microsoft, Walmart and Intel in 1999?  That doesn't make any sense.

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