Two Unwarranted Investment Fears

by Alexander Green

As I write, I’m here at The Oxford Club chapter meeting at the Intercontinental Hotel in Managua.

When we’re not eating tortillas and sipping margaritas, my colleagues and I – along with about 60 Oxford Club members – are surveying the global economy, making assessments about what lies ahead for world stock and bond markets.

However, two of the greatest fears voiced here are not genuine threats to your financial well-being, in my view. You’re probably hearing these opinions, too. So let me give you my take on them.

The first fear, especially among folks with a particular political viewpoint, is that the incoming Obama administration and the new Democratic Congress are going to fall prey to their worst instincts to tax, spend, regulate and redistribute, further damaging an already fragile economy. Again, I don’t buy this.

For starters, Obama has been tacking to the right on economic issues ever since he gained the Democratic nomination. In the primaries, he talked about renegotiating NAFTA. (To which Canadian Prime Minister Stephen Harper famously replied “Say what?”) But no longer. Obama also talked about raising top marginal tax rates. But not now.

It’s time for a reality check. Obama is getting economic advice from Paul Volcker and Robert Rubin (not Jerry Rubin.) He made economist Larry Summers the director of the White House National Economic Council.

Despite the heated rhetoric during the campaign, Obama is not a socialist. And the Republican minority in Congress will block far lefties from enacting protectionist legislation or fast-forwarding new redistributionist policies.

Top marginal tax rates are likely to remain the same at least until the end of next year. Why? If nothing else, it gives Democrats political cover. They can avoid criticism that they’re raising taxes during an economic downturn and can claim that the Bush tax cuts simply expired. This will play better when the mid-term elections roll around.

Yes, we’re going to get a massive fiscal stimulus because it has bi-partisan support. But so far Obama has shown that he intends to govern from the center, not the far left.

The other great fear I’m hearing is that this is not going to be just a tough recession but another depression. I don’t buy it. This is a nation of 300 million resourceful, enterprising people, not 300 million on a morphine drip. We will pull ourselves out of this. The Great Depression was caused primarily by policy errors. And those aren’t likely to be repeated.

Herbert Hoover raised taxes. Obama is promising to cut them for 95% of Americans. (Although I’ll concede he would boost the economy more – and actually generate increased revenues – by cutting marginal tax rates on small and large businesses and individuals.)

The government also tightened the money supply in the 1930s. Today the Federal Reserve has taken interest rates near zero and is sharply increasing the money supply. That’s the right thing to do.

In the 1930s, Congress passed high tariffs to protect domestic jobs and businesses from the threat of foreign competition. Predictably, this caused foreign countries to retaliate by blocking imports of American products. The result? International trade contracted over 25%. But no such nonsense is in the air today.

Bear in mind also, Bernanke is an expert on the Great Depression. He has published a book of his academic essays on the subject. (Check it out on Amazon. It’s a wonderful cure for insomnia.)

Bernanke will move heaven and earth to keep the U.S. economy from going into a deflationary spiral. And in this objective, we should all root for him. (Although, admittedly, cleaning up down the road is going to be a challenge.)

The bottom line is this: Economics in the 1930s was like medicine in the Victorian Era. We’ve learned a lot since then. Paul Volcker, Larry Summers and Ben Bernanke are not going to bleed the economy with leeches. We’re in a sharp economic contraction, yes. Should you avoid highly leveraged businesses and those in a weak competitive position? Absolutely.

But are we in for another Great Depression? The smart money – from Peter Lynch to Warren Buffett – is betting against it.

Maybe you should, too.

Comments

[Paul Killinger:]

All very well stated, sir. We'll see.

Jan 22 10:03 AM

[Paul Killinger:]

This is going to be a serious test of the resilience of our domestic and international economies. Unwinding the overcapacity and lunatic financial instruments we've created will take some doing.

I'm also not convinced the Congress is as benign a force as you describe. Their ability to meddle in the economy knows no bounds, and is one of the major reasons for the pickle we now find ourselves in.

I fervently hope you're thesis is correct, but it wouldn't take too many missteps from here (either by commission or omission) for things to go very wrong.

Jan 22 10:20 AM

[Paul Killinger:]

I recall very well the last time we came this way. Only the fortunate and timely combination of Reagan/Volker/Friedman saw us through, with considerably more pain than we've yet seen today.

One could argue we got extremely lucky. Let's hope the stars align in our favor once again.

Jan 22 10:38 AM

[happysoul77777:]

I have a deep-seated fear. My fear is that the stock market is structurally broken. Sellers have more tools than buyers. As a result, the market can never rally successfully.

Jan 22 06:06 PM