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The Hippo Market and Inflation

By    |   Monday, 12 April 2010 10:14 AM

Nervous investors are wondering if another stock market crash is in the works.

With the market up substantially since its March 2009 lows, there is serious cause for concern.

The good news is that the market may not be a bad place to store your money.

The bad news is that Western governments, led by the United States, are taking the wrong approach to fix the underlying economic problems caused by bloated government and staggering debt loads in the public and private sectors.

The reason the market offers something of a sanctuary is inflation. The United States, for example, is inflating its currency to deal with its massive shortfalls.

Last year’s Federal Reserve’s trillion dollar-plus intervention in the Treasury auction market, couched by policymakers as an effort to keep long-term interest rates low, was pure digital inflation.

Milton Friedman explains in “Money Mischief” — his seminal work on monetary policy — that inflation begins with ecstasy and ends in a hangover. Indeed, he uses the analogy of the drunk who only later regrets his episode of euphoria during the hangover that follows.

Get a free copy of Milton Friedman’s classic “Money Mischief”

Today the markets seem to show some euphoria.

On the positive side of the equation is that the stock market is sensitive to inflation and rises during periods of inflationary excess.

So, if the market corrects — or even crashes — it will likely bounce back and progress in tandem with inflation.

The Wall Street Journal Europe today discusses the “Hippo” market we may be experiencing. Instead of following traditional bull or bear cycles, the market may remain somewhat static with sporadic, and sometime violent, fits.

“Hippos spend long periods almost motionless in rivers and lakes,” the Journal explains. “But when disturbed, they can lash out, maiming anything in reach.”

The Journal says some investors are frightened today with prices “thrashing about wildly.”

The markets, in my opinion, would have stabilized long ago had the Obama administration taken a free-market approach to our economic woes.

Today, the U.S. government needs to scrounge for about a half trillion dollars in revenues to fulfill current spending obligations.

A free-market approach to such a problem would be to cut government spending while stimulating consumer activity through tax credits and cuts, with other incentives to corporations to increase capital spending.

Another long-term solution would be to increase legal immigration into the United States, using a “best and brightest” entry standard like Canada employs.

Instead, the Obama administration continues to take a statist approach, actually growing government expenditures while increasing taxes, especially on the rich.

The futility of this approach was revealed by data released by the non-partisan Tax Policy Center. It found that for the federal government to cover its half trillion shortfall by focusing on the higher-incomed taxpayers, the two top tax brackets would have to increase dramatically, from 33 and 35 percent today, to an amazing 72 and 77 percent. [Such tax increases would not cover state and local revenue shortfalls.]

Increasing top tax rates on the wealthy is reminiscent of the 1930s when New Deal policies raised the top rate to 90 percent.

The effect of such oppressive taxes on the highest earners was disastrous then, helping to keep the country in depression for more than a decade.

Obama and the Democrats in Congress won’t be so bold to raise tax rates so high. Instead, they will allow for an incremental approach, increasing taxes through several means.

For example, the Bush tax cuts automatically expire this year, yielding an immediate 10 percent tax increase on the highest brackets without Congress or the president lifting a finger.

Already, Nancy Pelosi and Obama economic adviser Paul Volcker are talking about a European-style VAT tax, tantamount to a national sales tax.

And proposed cap-and-trade legislation calls for new taxes on carbon-related energy sources. Expect new taxes on individuals, such as increases in inheritance taxes and, of course, more levies on corporations that are ultimately passed on to consumers.

The late Jack Kemp, an evangelist for supply side economics, was fond of saying that if you tax something, you get less of it; reduce taxes on the same thing and you get more. Today we are taxing economic growth, investment and productivity, with plans to tax consumer spending.

With such an approach, government revenues will actually shrink. Inflation will become more of an option for policymakers as a simple way to keep government spending high while eroding debt loads.

During periods like this, markets don’t crumble. But key sectors do better than others.

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Nervous investors are wondering if another stock market crash is in the works. With the market up substantially since its March 2009 lows, there is serious cause for concern. The good news is that the market may not be a bad place to store your money. The bad news is...
Monday, 12 April 2010 10:14 AM
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