John Hussman: Did Iraq and Tax Cuts Weaken the Economy?

Excerpt from the Hussman Funds' Weekly Market Comment (7/21/08)

It is widely believed that the enormous fiscal deficit created by these policies has been “stimulative.” The key question is, “stimulative to what?” Surely, not much of the answer can be found in stock valuations. Stock prices reflect the discounted present value of future cash flows. Even if the entire $500 billion was the present value of long-term cuts in dividend taxation, the “fair” present value of the U.S. stock market would increase by exactly the amount of the reduced tax burden. On a total stock market capitalization of about $15 trillion, $500 billion in tax cuts work out to a gain in value of about 3.3%. Clearly, the Bush tax cuts provided little impetus for anything but a short-term bounce in stock prices.

Combined with the costs of the Iraq war, however, they did produce a chain of transactions that weakened the U.S. economy and debased the U.S. financial system.

One of the first effects of the U.S. fiscal deficit was a deterioration of the U.S. trade position. By definition, if the U.S. imports $100 worth of “stuff” from other countries, it must export $100 worth of “stuff” in return. Suppose that we import $100 of foreign goods and services, but we are also running a federal deficit, so we pay for part of that by exporting $30 of Treasury securities to foreigners. By necessity, our total exports of goods and services will only be $70. This is not a theory, but an accounting identity (the surplus on capital account – in this case $30 of securities exported to foreigners – is always the reverse of the deficit on current account, in this case a -$30 trade deficit on goods and services).

Put simply, the massive fiscal deficit of recent years has required the U.S. to run a deep current account deficit. Moreover, our need to foist government liabilities into foreign hands has resulted in a large depreciation in the value of the U.S. dollar (if foreigners were eagerly snapping up our “stuff,” the U.S. dollar would be appreciating instead). When the domestic savings of the nation as a whole are insufficient to finance government deficits and private investment, foreign savings must be imported through the sale of securities. Our insufficient national saving has had the effect of strengthening the hand of foreign competitors, and continues to require us to sell U.S. assets into foreign hands to finance the shortfall (last week's agreed takeover of Budweiser – the Great American Beer – to a foreign company is particularly emblematic).

Comments

[GaryD:]

Budweiser still sucks.

2008 Jul 23 05:34 PM

[Charlie Str...:]

You forgot to mention the fact that this has been the worst decade for U.S. stocks since the Great Depression, and that the stock market is a leading economic indicator.

2008 Jul 23 05:52 PM

[rdr4:]

didn't a country formerly called USSR go bankrupt fighting an endless war?

2008 Jul 24 09:17 AM

[User 76715:]

But didn't the tax rate cuts actually produce more tax revenue?

2008 Jul 24 10:32 AM

[Charlie Str...:]

User 76715, IIRC, one of the big 4 accounting firms did a study of multiple countries which showed that supply side tax cuts work. But I can't remember if the study considered what is known in economics as the "crowding out effect" which simply means that the more money the Federal government takes in from increased tax revenues than the less money is left over for the private sector (to stimulate economic growth).

2008 Jul 24 10:52 AM

[Crookedwood:]

The good life and wars financed with money from foreigners is a formula for economic distruction. We knew that. Wish George Bush had.

2008 Jul 24 10:53 AM