Monday, March 05, 2007

I'll let the Professionals handle this one

Russ in Orcutt looks out at the American economy and sees a looming disaster:

The Bush administration has preached lowered taxes as pure panacea, relying on growing our way out of deficit spending.

Former advisor Gregory Mankiw dissents, saying “cuts in income taxes, long term, deliver a boost that recoups less than half of the lost revenue.”


We cannot go on failing to pay our way, trusting that trickle-down theory will succeed. We can well afford higher taxes levied on a far more progressive basis. I find it sickening to see young people die defending us in a questionable war while we the fortunate indulge ourselves with tax breaks.

Unless we demand realistic fiscal responsibility, we are headed for deep trouble. The current boom will not last. When it finally ends, it may seem like 1929 all over again.

As to watching young people die while the fortunate indulge themselves...well, sounds like Russ has some issues to work through. Meanwhile, I'll let a professional tackle the other point(s):

The U.S. stock markets were looking for a correction for some time now and on Tuesday they found it: a 3.5% sell-off across the board. The plunge follows a 20% run-up that began last summer, and some analysts believe it was overdue. Indeed, 3% corrections are normal and healthy. Legendary financier J.P. Morgan knew this a hundred years ago when he told a congressional panel that prices fluctuate. But the trigger for Tuesday's drop undoubtedly came from China.

The Chinese have sent a Shanghai flu across the globe. There is talk in China's government circles of slowing its boom and the "speculative" stock rise that has taken place over the past 18 months. Higher reserve requirements for banks, tighter interest rates, stricter implementation of a capital-gains land tax, and perhaps some form of capital controls are all in the rumor mill. This sounds like root-canal advice from the U.S. Treasury and the IMF, which somehow are dissatisfied with 10% growth and 2% inflation in China. France, Germany, Japan or Latin America should have it so bad.

At home in the U.S., there are still housing-slump worries and concerns about an inventory correction in autos and factories. Former Federal Reserve Chairman Alan Greenspan this week even predicted a recession, naming the budget deficit as the cause. Huh? The deficit is evaporating as record tax revenues are being generated by a solid economy, itself a function of the low marginal tax rates put in place by President Bush.

Current Fed Chairman Ben Bernanke is looking for a soft economic landing, and I agree.A quick tour of the data: Consumer incomes keep rising amidst low unemployment and record job creation. Ditto for business profits -- the mother's milk of the economy and rising stocks. Exports are strong. An inventory correction, which helped knock fourth-quarter GDP down to 2.2% from 3.5%, will pass. As yet there is no evidence that a sub-prime mortgage lending problem is spreading. There is no economy-wide credit crunch. And bond rates are a low 4.5%, adding more value to stocks. The prosperity boom is alive and well.

In fact, using a modest 8% growth estimate for 2007 earnings, and capitalizing that profits forecast with a 4.5% bond yield, shares appear to be anywhere from 15% to 25% undervalued today. Put another way, the 6.7% forward earnings yield of the S&P 500 compares very favorably to a 4.5% Treasury bond or a 5.7% A-rated corporate bond.

The high-tech, productivity-driven U.S. economy is more durable and flexible than its liberal-left critics will ever admit. It is a private-sector free-enterprise economy, not a government-planned one. Innovation is strong and entrepreneurial spirits are high. The four prosperity killers, a paradigm coined by Arthur Laffer many years ago, all look dormant: inflation, taxes and regulatory burdens are low, while free trade keeps expanding.One of the most underrated aspects of this bull-market economy is the sharp drop in marginal tax rates on capital formation. After the levies on capital gains and dividends were reduced to a scant 15% in 2003, the supply of easy capital surged, holding down real interest rates and expanding internally generated liquidity. This, plus record profits, has been the major source of the new-liquidity generation that has fueled stock markets at home and abroad.

Liberal seers have been predicting the downfall of U.S. stocks and the economy several times a year since the Bush boom began back in 2003. Yet at comparable points in the business cycle, wages and wealth have outperformed during the current expansion.

My advice to investors is to remain optimistic and stay in stocks for the long term, since economic freedom is the tried and true path to growth and prosperity. Isaiah Berlin wrote many years ago that hedgehogs always win the long-term race against foxes. Message to the investor class: Hold that thought.

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