THE BEAR'S LAIR Quarter-century fast forward
By Martin Hutchinson
With an unpopular war, a deep recession, an irresistibly growing public sector,
excessively rapid money supply growth that may spark off inflation, a
dangerously large payments deficit and a workforce excruciatingly vulnerable to
international competition, the United States is today in a similar position to
that of 1970-71.
The current objective must surely be to produce an explosively expanding new
technology, declining inflation with complete market confidence in the Federal
Reserve, a budget approaching balance, a moderate payments deficit and a
workforce of immense international competitiveness and spiraling remuneration
- in other words, roughly the position of 1995.
So how do we reproduce a quarter-century of history in a few years?
Going the other way, from 1995 to a reproduction of 1970, was quite easy and
took only 14 years. The explosively expanding new technology became an infinite
source of investor losses through the magic of the market for initial public
offerings in the late 1990s, plus a small number of established new companies
such as Amazon.com, eBay and Google. Inflation was suppressed by the forces of
globalization, which reduced costs by empowering low-cost emerging market
competitors.
However, once those competitors entered fully into the world economy and their
own costs began to rise, inflation returned. And once again, the United States
is mired in an unpopular war.
Market confidence in the Fed remained absolute for a decade, outlasting the
retirement of Fed chairman Alan Greenspan in 2006. But under his successor, Ben
Bernanke, it has begun to waver. The budget was balanced only briefly, and the
public sector is once again bloating uncontrollably. The US balance of payments
deficit has quadrupled, not producing a currency crisis, since we are no longer
on the Bretton Woods fixed parity system, but an endlessly declining dollar.
The US workforce is no longer particularly competitive against labor in
emerging markets, and its remuneration even at the top is spiraling downwards
rather than upwards.
2009 is not 1970; there are a number of important differences. But it would
take a brave man to claim that the US economy was definitively better
positioned today than in 1970. Its position is clearly vastly inferior to that
of 1995. It is thus instructive to look at how the United States moved from its
1970 situation to its 1995 situation, and see which factors could be replicated
today.
First, and perhaps most important, was a reduction beginning around 1973 in the
uncertainty of business's regulatory environment. The late 1960s and early
1970s were a period of extraordinary government activism, much of which forced
costly new mandates onto business, particularly in the areas of human resources
and environmental controls. Notable examples of the latter were the Clean Air
Act of 1970, the Environmental Policy Act of 1970 and the Corporate Average
Fuel Economy legislation of 1975.
In addition, the antitrust environment of the time was highly arbitrary, with
major antitrust cases being instituted against General Motors in 1959, General
Electric in 1960, IBM in 1969 and AT&T in 1974. Railroad, trucking and
airline businesses were highly regulated, with government bodies setting
prices.
The recessions of 1970, 1974 and 1980-82, with their accompanying bankruptcies,
brought a realization that business could not continue to be loaded with
ever-increasing costs and regulations. Starting with the deregulation of
airlines, from the late 1970s to the 1990s, businesses could be increasingly
confident that they would not be subject to further major government
depredation.
Second, also beginning around 1970, there was a steady increase in the economic
returns for education, entrepreneurial activity and hard work. Part of this
came from the reductions in top income tax rates in 1981 and 1986, but there
was also a substantial widening in income differentials between the highly
skilled and the unskilled.
At the bottom of the scale, rapid immigration following the 1965 Immigration
Act reduced the power of unionized labor, which declined from almost 30% to
around 10% of the private sector workforce. Immigration also placed substantial
downward pressure on real incomes for the unskilled. Thus the real income of
adult male workers with only a high school qualification declined by a quarter
between 1970 and 1995, while female workers barely broke even. Even overall,
real male median personal incomes in 1995 were 6% below those of 1970, although
real female personal incomes rose 50% during the period. Per capital gross
domestic product increased by two thirds, a huge proportion of which went to
capitalists and the most highly skilled, while the wage pressure on low-skilled
labor increased US competitiveness.
A third change that has been underrated was the increasing ease of raising
venture capital. The first modern venture capital company, American Research
and Development, was founded in 1946 and had its first big success with Digital
Equipment in 1957. But in 1970, the industry was still in its infancy. By 1995,
venture capital was readily available for almost any new idea in the tech
sector - indeed, the next five years were to produce a venture capital glut.
The 1978 reduction in the capital gains tax assisted the development of this
industry but did not cause it.
Finally, the great achievement of the 1970-95 period was the conquest of
inflation, achieved by a decade of tighter money than had ever been thought
either desirable or politically possible. The elimination of inflation focused
capital on those enterprises that were truly profitable, eliminating
illusionary inflation-produced gains. It also reduced nominal interest rates,
increasing the ability to restructure corporations that had grown flaccid.
A few of these forces are still present. The tax system is probably not going
back to 1970, either in top marginal income tax or in capital gains tax rates.
The ending of the Vietnam War, which reunited society and released resources
for civilian uses, will probably be matched by a winding down of the wars in
Iraq and Afghanistan.
However, most other factors that produced improvement between 1970 and 1995
have reversed. Since the collapse of the dot-com bubble, the venture capital
business has gone into a deep funk. During the 2003-07 boom, the money pools
that would previously have supplied venture capital were diverted into private
equity funds and hedge funds, neither of which have economic value-added
commensurate with their current enormous size.
Further, "alternative investments" as an asset class have been deeply tainted
by the excessive fees charged by managers and by such excrescences as the
present Bernard Madoff scandal. Hence raising capital for new ventures is
likely to be more difficult in the next decade than it has been since at least
the downturn of 1973-74.
Fiscal and monetary policies are also likely to be much less helpful than in
the 1980s. Real interest rates remain substantially negative, which will cause
a resurgence of inflation and a diversion of resources from productive
investments into asset- and commodity-based investments that add little
economic value.
The public sector is growing at an appalling rate, and its deficits are
exploding. Those deficits will divert increasing percentages of a capital pool
that is likely to be much smaller than in recent years. Recent political
developments suggest fiscal expansionism is likely to last for several years,
although there must be some hope of reversing monetary profligacy by replacing
Bernanke at the Fed. Nevertheless, substantial progress towards the 1995 fiscal
and monetary nirvana seems unlikely before 2015 or so at the earliest.
A third and very disquieting development has been the sharp increase in
regulatory uncertainty. Existing systems of regulation have been discredited by
the financial collapse, while government has shown in the past few months that
it is capable of behaving entirely arbitrarily, spending US$150 billion to
rescue the house of cards at AIG and guaranteeing $300 billion to rescue badly
run and repeated flirter with disaster Citigroup while allowing Lehman
Brothers, without a stain on its reputation, to crash into bankruptcy. With a
new administration and a heavy Democrat congressional majority, the urge to
regulate will be almost uncontrollable, and both healthcare reform and
global-warming regulations are likely to impose huge new costs on the US
economy.
There are also additional negative factors today that were not present in
either 1970 or 1995. With the explosion in global communications capability, US
workers now face competition from emerging-markets workers who are generally
younger, often better educated and have, through competing internationally,
acquired capabilities equal to those of their US counterparts.
As I have written, global living standards are likely to equalize to a large
extent over the next few decades, and the well-paid US workforce will be major
victims of this. The leveling tendency will not be limited to the lower-skilled
- though mass immigration, if permitted, will make their lives especially
miserable - but will extend up to the PhD level in many fields. After all, an
Indian IT worker with an advanced degree and five years of experience is likely
to be fully as capable and productive as his US counterpart.
The miserable, niggardly advances of the last four decades in most Americans'
living standards may come to seem like a lost nirvana to the unfortunate
workers forced into the full rigors of global competition.
Finally, the decline in transparency in the investment area and business
generally appears to have caused a rise in corruption. For example, the US
score on Transparency International's Corruption Perceptions Index has declined
from 7.8 to 7.3 between 1995 and 2008. In the political field, this datum is
confirmed by the doubling in the number of Washington lobbyists since 2000 and
the 10-fold increase in spending "earmarks" since 1995.
The Madoff scandal, as well as demonstrating criminality's enormous costs to
society, also symbolizes the poisoning of established social networks by modern
finance - Madoff's former college friends were more likely to be swindled by
him, not less likely as would traditionally have been expected. Increased
corruption represents a deadweight cost to the economy, both through the wealth
siphoned off directly and through the increased legal and policing costs
necessary to surmount it.
The chance of a transition from 1970 to 1995 thus appears small, whether over a
short period or even over the 25 years it took the first time around (though we
must bear in mind that even five years may make a huge change in the most
entrenched of political and economic realities.) On the other hand, 1970 was by
no means the worst period in US history; a similar analysis would fortunately
show that we are also unlikely to regress from our current 1970 to a renewed
1932.
Instead, we appear to be heading towards a new destination, at present obscure.
That destination need not represent a deterioration from our current position.
However, ensuring that it doesn't will require us to secure the low innovation
taxes and tight money of the 1980-2000 period, while minimizing any added
burdens of regulatory uncertainty, runaway public spending and new social and
environmental programs. If those policy requirements are not met, the rigors of
competing in a fully globalized economy will impose a grievous cost on US
living standards.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-09 David W Tice & Associates.)
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