by Rich Karlgaard
In her magnificent (and prescient) book The Forgotten Man Amity Shlaes creates a useful metaphor that is easy to grasp and explains a lot. It is the idea that capital can go on strike.
Capital is on strike now. It is one of the causes of the crash of 2008 and the fourth-quarter mini-depression.
Ben Bernanke is working hard to pop the Treasury bubble–which grows in times of deflation fears–in order to get capital off the strike line and back into productive investment. Bernanke is using the only tool available to him. He is “dropping money from a helicopter,” some $2 trillion worth since September.
(The helicopter quip was originally Milton Friedman’s. Don’t you wonder what Uncle Milt would have to say about the 2008 crash?)
Reinflation is one way to get capital off the strike line and back into the game. But reinflation is like medicine. You must get the dose right and you can’t administer it forever because it will ultimately weaken the patient and cause its own problems. Proper fiscal policy is the way to keep capital in productive investment. That would mean applying reasonably low tax rates on personal and corporate income and reasonably low rates on capital gains and dividends.
As Shlaes writes in The Forgotten Man, if Hoover caused the Depression, FDR prolonged it by constantly attacking the investor class, whom he called the “malefactors of great wealth”–a phrase originally said by the first Roosevelt, Theodore. FDR’s attempt to pack the Supreme Court in 1937 was driven in part by his wish to tax the rich retroactively.
Consider this thought experiment: Imagine if the incoming Congress and Obama administration raised taxes on capital gains to 30% only to discover that the revenue receipts were not as high as planned. So imagine they then applied the 30% rate to all gains since 2003.
That’s essentially what Roosevelt wanted to do. Sensibly enough, the Supreme Court rebuffed him. Thus did FDR try to pack the Court in 1937 by adding one new justice for every sitting justice over age 70.
That’s how capital goes on strike. It goes on strike when it is attacked or when the rules are unclear.
If President-elect Obama wants to be a hero and get credit for pulling the economy out of the ditch, he has to get capital off the strike line. Demand-side stimulus, whatever its merits might be, won’t do that. The only policy levers that will get capital back in the productivity game is a monetary reinflation accompanied by the promise of reasonably low tax rates–let’s say 20% for capital gains, dividends and corporate rates.
The capital gains tax, of course, must be indexed for inflation.
If Obama can get capital back in the game, the economy will recover quickly. Elsewhere on today’s Edgelings (and in the Wall Street Journal) my friend Mike Malone suggests some regulatory reforms that will also get capital off the strike line. READ MALONE’S STORY HERE