Stimulating Conversation

Posted: Jan 22, 2008 7:34 PM
Stimulating Conversation

On Friday I was invited to a conference call with Ed Lazear, Chairman of the President’s Council of Economic Advisors. The call was devoted to the topic of an economic stimulus package being considered by the President. Supply side economists like me were respectful but somewhat skeptical of the idea of the government sending out checks to the public in the hopes that we’ll spend the money. The idea is that we have a short run slow-down and we need a quick kick to get us through this rough spot. I don’t agree.

The problem with a short run stimulus package is that we don’t have a short-run stimulus problem; we have a long run investment problem. Business owners and managers see a rising political tide of economic populism and that is a very dicey environment for long term business planning. And when uncertainty is high, time horizons shrink.

Would you be willing to seriously consider buying some shares in Chinese companies? The answer is probably ‘yes’. What about buying a house in China? Probably not. You just don’t know what things are going to be like there in 15 or 20 years. If their market goes down, you can always sell the stock, it’s a liquid asset. But if the Chinese suddenly snap back to hyper-nationalism (as they have done in the past), you’re home in China will be an anchor. This doesn’t just apply to different countries; it applies to different ages. Brian Anderson former head of Chase Manhattan Bank makes this point in his excellent American economic history, Economics in the Public Interest. The more risk, the more the desire for liquidity. The less liquidity, the better long term return. In other words, building factories or power plants is a risky business with high long term returns. The converse of this is that an environment in which price levels, interest rates and tax rates are highly susceptible to surges of anti-business fanaticism, is an environment in which entrepreneurs are hesitant to take the big risks that lead to the big returns. We’ll loads of web sites, and maybe we’ll even build a handful of Applebee’s, but very, very few power plants.

What will America be like 25 years from now? What will it be like 5 years from now? What will it be like 1 year from now? If I was confident that America would be optimistic, freedom-oriented, dynamic and entrepreneurial for the next quarter century – I’d invest most of my money in nuclear power plants. But I’m not sure enough to stake the next generation’s wealth on something like that. If I were sure that 2009 would be a low tax year with a stable interest rate environment and fair legal treatment of all business entities: I’d put most of our money in homebuilders, mortgage bankers, HMOs, and pharmaceutical companies. But I’m not sure of that.

If I were sure that next year would be a high tax year, I’d sell most of my stocks and put a lot of money into an index of tax free municipal bonds. That’s exactly what investors have been doing. As the stock market tanks, the munie market moves up, right in line with Hillary’s election prospects. Just for fun, take the intrade political future’s market contract on Republicans to win the White House and overlay it with the Dow Jones Industrial Average. They move together like Fred and Ginger. In other words, the future’s market, the stock market and the municipal bond market are all singing the same tune – Democrat win, high taxes, low stock prices.

I hope the investors are wrong. They were in 1980. Only time will tell whether they are in 2008.