The risks that lay ahead of us.

Looking forward there are four major risks for the United States economy, all of the 'Four Prosperity Killers' created by Arthur Laffer many years ago are now inminent.

1 INFLATION = Generated by too much money chasing to many goods, loose money, quantitative easing. The FED has recently bought non-treasuries (Mortgage-backed securities) will be difficult to respond when inflationary forces start to come in, they will not get rid of them once the velocity of money starts to come back up again. This is a factor for future political preasures, the US central bank independence is under stake.

2 HIGHER TAX RATES = Increase in top marginal income taxes (35->39.8%), increase in payroll taxes (to fund a bankrupt Social Security scheme), increase in middle class taxes through fiscal drag (product of higher inflation middle class incomes will be silently moved to higher tax brackets). These will all take out incentives for people to work, so they will do less work, simply as that!

3 RE-REGULATION = Cap-and-Trade (aka Cap-and-Tax), Unionization (repeal of the secret ballot), Health Sector (price controls and central planning)

4 TRADE PROTECTIONISM = 'Buy American' legislation, Bank nationalisation, Automobile bailouts, Mexico Trucks, Carbon traiff from foreign countires.

These policies go against a solid recovery of the economy. I'm not saying that the economy will not recover, infact it will (and not because of Obama or God), but it will be weaker, slower than it would otherwise would be.

One of my favourite quotes from Arthur Laffer is "If you tax people who work and you pay people who don't work. Don't be surprised if you find a lot of people not working."

What fueled the financial crisis into a global recession.

In the last post I wrote about the root causes of the financial crisis, now I'd like to write about what are the three things that are making things much worse.

1-MARK-TO-MARKET ACCOUNTING: a more proper name should be mark-to-liquidation. Banks had to artificially knok down the value of assets from their balance sheets, that lead to risks in the stability of the banking system that made banks to hoard cash and to not lend to each other even if they where cash flow positive. That was a major cause for the so-called credit crunch.

2-POLITICAL CHANGE TO BIG GOVERNMENT: after 25 years of Reganomics where free-market monetarism spread around the world, the winds started to turn and the era of big goverment keynesianism started it's way. It all started with the always-proved-useless rebates the last year of the Bush administration, it continued with the bank and auto industry bailouts, and then it worsened with the Obama budjet proposal. The stock market was off 10% from it's highs but started to freefall in september 2008 when Obama started to lead the polls. Expectations make a crucial role in the stock market and the economy. Today we expect in the future to have a bigger burden of taxes and regulations that stop investment, entrepreneurship and growth. Not only in the US, countries from all over the world are changing policy.

3-PROTECTIONISM AND NATIONALIZATION: The 'buy american' legislation enacted by the Democratic congress in my opinion is just the start of the well known game (the US tried it with the disastrous Smooth-Hawley Act) of retortions and counterretortions that will make international trade a nightmare. Nationalizations of banks around the world is not only swiping out current shareholders but is also very dangerous for the future.

Credit is the blood of the economy, and if the blood is controlled by government we are in deep trouble.

The cause of the 2008 Financial Crisis

Was free market capitalism the root cause of the present crisis?

Since the the present crisis started in the United States, many blame excess of capitalism and deregulation, two flagships of the american way of life since Ronald Reagan. From their point of view the blame goes to greedy banks and headge funds that spreaded the toxic mortgages (subprime) to uninformed people around the globe. They think that regulation could have prevented these subprime mortgages to be made and that free markets have gone too far. Their solution is more government intervention in the system.

Nothing of that is true. Nothing of that is the solution.

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The present financial mess has three authors.

1- BAD MONETARY POLICY BY THE FED-RESERVE (Gvmt Central Bank)

2- COMMUNITY REINVESTMENT ACT (Government Regulation)

3- FANNIEMAE-FREDDIEMAC (Governement Sponsored Enterprises)

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The story is this:

1- It all started with the expansionary monetary policy by the FED since 2002. This created three things: dollar depreciation against major currencies, rising housing prices, rising oil prices. Contineous rising of housing prices, aka housing bubble, made people run for new houses before their rised in price again. This created an overinvestment in the housing sector. And when inflation signals started to pick up in 2006 the FED started to rise interest rates. That tightening in the monetary policy made the missallocation of resources in housing clear. The bubble they created started to burst.

2- The Community Reinvestment act in fact put a gun to private banks and told them not to discriminate low-income high-risk people asking for a loan. That made credit requirements too low and banks concieded loss making loans. When the bubble burst they suffered from them. That lead some banks such as Lehman Brothers into bankruptcy. Clogging the credit between banks, aka overnight interbank lending.

3- Government sponsored enterprises FannieMae and FreddieMac that had more than half of the mortgage market made high risk mortgages to people that couldn't afford them. They made them because they had an intrinsic guarrantee of the federal government. When the bubble burst those subprime mortgages entered in default, leading the two agencies to complete failure and where bailed out.

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Summing up:

1-Monetary policy interfered with the normal free market trends.

2-Regulation obliged private banks to missalocate their capital and fail.

3-GSE failed because of their losses-socializing guarrantee from government.

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The real facts are complex and difficult to explain to an economics illiterate.

CAPITALISM IS NOT TO BLAME. GOVERNMENT IS THE PROBLEM.

It is easy and simple to blame capitalism. It politicaly impossible for politicians to blame themselves. Remember, the blame is always on the other, right?

The Tax Misery Index

Now, let's take a look at countries based on their taxation schemes.
This is the 2008 Tax Misery Index made by Forbes:

For a larger view go to: http://www.forbes.com/global/2008/0407/060_2.html

This index constructed by adding up each percentage point tax of various taxes: Corporate Income Tax, Personal Income Tax, Wealth Tax, Social Security Taxes and VAT/Sales Tax.

As we can see, there is big variety between areas of the world when it comes to taxation.

In the top of the chart we have high-taxed nations such as France, Belgium, Italy, Japan and Argentina. All these have had stagnant economic growth during the last decade. Develeloped economies have stopped their growth such as Japan and underdeveloped such as Argentina has even reduced their GDP/Capita.
On the bottom - low tax jurisdictions such as Hong Kong, United Arab Emirates, Qatar, Singapore, Russia and Eastern Europe - have been soaring. Their low tax regimes have encouraged foreign capital investment, increase in productivity and resulted in a higher standard of living.

There is evidently a link between taxation schemes and growth.
In the last eight years tax competition has made tax rates go down around the globe. I think that part of the increase in world growth has to be atributed to increased tax competition.
So if the evidence is so clear why do governments just cut taxes to increase growth? Well, the taxation scheme is designed on the spending requirements. If they are big spenders they need larger revenues. The problem is that government spends too much.

As Ronald Reagan once said about government interfearence in the economy: "Government is like a baby. An alimentary canal with a big appetite at one end and no sense of responsibility at the other."

Economic Freedom in the World 2009

I would like to dedicate my first post to a view of the world from this perspective.

For more detail information visit: http://www.heritage.org/index/

This map is made by the Heritage Foundation and indicates the level of economic freedom in each country. Darker blue means that countries are more free.
At a first glance we can see there is a direct and unquestionable link between economic freedom and prosperity.
Countries like North Korea, Cuba, Zimbabwe and Venezuela have a repressed economy and have low levels of standard of living and are governed by ruthless dictators. On the other hand, others like Hong Kong, Singapore, Australia and USA have one of the highest standard of living and have stable democracies.

As Nobel-Prize economist Milton Friedman said: "You cannot have political and social freedom without a large measure of economic freedom."