When rich guys' superstitions pose a public threat

Posted: Feb 21, 2005 12:00 AM

According to USA Today, "Our greatest businessmen (Bill Gates and Warren Buffett) think we are doomed to fail." Gates demonstrated his pessimism in an interview at the World Economic Forum in Davos, Switzerland, when he told reporters, "I'm short the dollar. ... The ol' dollar, it's gonna go down."

 It's not surprising that the world's richest man came down from the Alps pessimistic. The misconceptions, myths and superstitions that pass for sound economics in Europe these days remind us that while socialism may be dead as a political force in the world, its zeitgeist of radical egalitarian leveling, gigantic government and bureaucratic control over the minutiae of everyday life lives on in the hearts of European politicians.

German Deputy Finance Minister Caio Koch-Weiser is illustrative. At Davos he was preaching that the U.S. budget deficit is "the No. 1 risk, disregarding geopolitical risks" to the global economy. He said it was urgent for President Bush to offer a "credible" plan for getting the deficit under control.

The unstated plan, of course, is a pre-emptive strike" against estimated future budget deficits in the form of higher tax rates on investors, ostensibly to improve investor confidence. It's nothing but 21st-century economic quackery, much like 19th-century physicians thought the way to cure a sick man was to bleed him.

 The "Genius of Microsoft" also has heard this doom and gloom preached by his close friend and bridge partner, the second-richest man in the world, Buffett, who told Forbes Magazine recently: "The rest of the world owns $10 trillion of us, or $3 trillion net. If lots of people try to leave the market, we'll have chaos because they won't get through the door."

If everyone tried to get their money out of the bank at once, we would have chaos because they wouldn't get through the door, either. It's called a bank run, and it doesn't happen because the bank owes a lot of depositors money. It happens only if the bank has made a lot of bad loans. Just the opposite is the case with the U.S. economy in which this $10 trillion is invested: It is the strongest economy in the world.

 Buffett is a brilliant stock-picker-turned-gambler who indulges in currency speculation against the dollar. He is part of a circle of super-rich billionaires such as George Soros and Ted Turner, who, through arrogance and/or guilt, seem to think free markets hurt the average guy and work only for those lucky enough to inherit their wealth or brilliant enough (like themselves) to use markets to exploit the rest of the world.

Buffett believes the United States is awash in so much debt, both domestically and internationally, that it will cause higher interest rates and a widening trade deficit, followed by a crisis of confidence leading to a run on the dollar and economic decline, if not financial collapse. It's a version of what I've called Rubinonomics, after former Clinton Treasury Secretary Robert Rubin. Rubin, along with liberal economists Allen Sinai and Peter Orszag, wrote a paper a year ago summarizing Rubinonomics:

Budget deficits decrease national saving, which reduces domestic investment and increases borrowing from abroad. ... The reduction in national saving raises domestic interest rates, which dampens investment and attracts capital from abroad. The external borrowing that helps to finance the budget deficit is reflected in a larger current account deficit. ... The reduction in domestic investment (which lowers productivity growth) and the increase in the current account deficit (which requires that more of the returns from the domestic capital stock accrue to foreigners) both reduce future national income.

 The only problem is, there is absolutely no empirical evidence to support the theory. Indeed, history disproves virtually every linkage it draws. For example, as economist Alan Reynolds has pointed out, from 1981 to 1989, when U.S. deficits averaged 3.8 percent of GDP, the national savings rate was 18.2 percent of GDP. From 1998 to 2001, while the U.S. budget was in surplus, national savings was less, 17.5 percent of GDP. During the late 1990s, when the projected budget surplus was increasing steadily and interest rates should have been falling according to Rubinonomics, real interest rates were rising, and the economy, far from struggling, was soaring.

Reynolds also demolishes the so-called "twin deficits" bugaboo that seems to have Buffett so bent out of shape. In 1991, he points out, the budget deficit was 4.7 percent of GDP, up from 3.9 percent in 1989. The current account, however, had moved from a deficit of 1.8 percent in 1989 to a small surplus in 1991. In each subsequent year the budget deficit grew smaller and the current account grew larger.

By 1998, the budget surplus equaled 0.8 percent of GDP, but the current account deficit was 2.5 percent. By 2000, the budget surplus equaled 2.4 percent of GDP, but the current account deficit was 4.4 percent. It's no longer economic theory when an idea like the "twin deficit" so entrenches itself that people are unable to change their minds when confronted with evidence to the contrary; it's superstition and myth.

 The facts are quite different from what Buffett imagines. Tax increases don't increase national savings by lowering public-sector borrowing; they reduce incentives to work, save and invest, thus reducing saving and lowering economic growth. Conversely, tax rate reductions increase incentives to do all three. After the Bush income tax rate reductions reduced the penalty on working, realizing capital gains and earning dividends, the effects on economic growth were immediate and dramatic.

After business fixed investment fell for a record straight nine quarters, it began growing in 2003 and has continued to grow at double-digit rates ever since. Tax revenues, as a consequence, are rising, as well. The deficit is beginning to shrink, and if Congress will just hold the line on federal spending growth, the budget will come into balance in a few years.

Rich guys have the right to believe whatever superstitions they desire, but their wealth can't buy them a free pass around the facts.