Ignoring Known Knowns

New York, 4 May 2011.

We live in a world full of known unknowns and unknown unknowns.

To spice things up, we are also ignoring many known knowns.

Here are some examples of these overlooked truths:

A weak currency hurts exports.

Low interest rates increase the cost of capital.

Fiscal and monetary stimuli slow down the economy.

Wealth transfer destroys the social fabric of a country.

And yes, lower taxes increase fiscal revenues. Substantially.

All this is easily demonstrable.

But a habit of looking for short term solutions has clouded our collective brain and has made it impossible to look beyond the seemingly obvious.

An obsession with short term fixes has taken over the civilized world.

This is a society that cures obesity with miraculous pills to avoid dieting.

One does not have to look back to the 1980’s to find evidence of revenue growth due to lower taxes.

Only a few years ago, the US government successfully and dramatically increased its revenues thanks to tax cuts.

Three years after the last tax cuts, federal revenues were not only up more than 30%.

They also represented a higher percentage of GDP.

This is a known known.

Only a Nobel laureate in economics can deny this and turn a 30% increase in revenues into a loss.

Ireland offers another clear example of how governments applying reasonable tax rates always end up raking in more revenues.

Notwithstanding a corporate tax rate that is less than half the rate of France’s, the Irish get more income from it as a percentage of GDP than the French.

This is, again, well known.

But, of course, unacceptable.

It drives Germany and France nuts.

They want Ireland to raise tax rates to conform to European orthodoxy.

This in spite of evidence that it would substantially diminish revenues.

And, incidentally, a collapse in direct investments.

With such logic one wonders why Germany and France do not have more Nobel laureates in economics.

Europeans love high taxes because it allows them to be the champions of wealth redistribution.

Their righteousness has no boundary when it comes to lecturing the world about social policies.

That is how Europeans compensate for their lack of generosity.

In the US, there are 110,000 grant-making private foundations.

In 2007 alone, American individuals gave $ 243 billion to charity.

That amount came down only 4% the following year, the year of Lehman.

Try to find such a tradition of giving in Europe.

It may have existed in the past, but it ain’t there no more.

Here is why.

Charity on the Old Continent is no longer the people’s business.

It is the government’s task.

Europeans have subcontracted generosity to bureaucrats.

They pay taxes and the bureaucrats then decide how to allocate the goodies.

It really simplifies one’s life.

It puts at once citizens’ conscience at peace and eliminates all further difficult decisions.

However, by managing their social responsibility by proxy, Europeans have changed the social dynamic.

For instance, it has made them cheap.

Just ask New York waiters.

They know to add a tip to the bill when patrons speak French or Dutch.

As far as economic stimulus programs is concerned, one only needs to look at Japan.

For over 20 years now, every new Prime Minister has introduced at least one new stimulus package.

To no avail.

Do we really believe the outcome will be different in the US?

The 1.8% GDP growth in Q1 does not seem to indicate that, in spite of some Nobel laureates’ views…

But I believe this topic to be well covered in the press, with or without facts.

So let’s turn to the supposed benefits of a weak currency.

Many pundits still believe that it is good for exports.

Really?

Tell that to the Germans or the Japanese who have enjoyed unparalleled export succes.

In Germany they know the strong deutsche mark, and its offspring the euro, has always been a plus.

It has been a major factor in making the German economy more dependent on high value added products.

In the long run, such a “midtech” economy succeeds on the merits of the quality of the products, not a short term cost advantage.

Capitalism works because of competition.

Competition makes companies more productive and innovative.

Tough competition makes them even better.

Daimler, BMW and Audi all benefited from the strong deutsche mark because it forced manufacturers to constantly focus on adding value.

If they could not sell cheaper cars, they had to sell better cars.

At better prices.

It has served them well.

Now, compare these cars to the East German Trabant.

The lack of competition produced a very different result.

Devaluing the currency would not in the least have made these improved lawnmowers more exportable.

There was no price at which one would have wanted a Trabant.

Weak currencies are a blessing only for economies dependent on export of commodities and import of tourism.

Developed economies make a big mistake in relying on a weak currency to boost their exports.

It cheapens their economic fabric.

One way to bring a currency down is by keeping interest rates low.

Negative real interest rates will often do it, since money tends to look for positive returns.

Why else is the dollar weak?

Anyway, the rate that matters to the economy is the long term rate, not the benchmark.

Housing, infrastructure or capital goods are financed with rates linked to the long end of the yield curve.

The problem with keeping the benchmark too low for too long is that inflationary expectations will push the long term yield up.

Hence, the cost of capital for the real economy goes up.

Even Nobel prize winners understand this.

loans.

Finally, some other short term thinking is leading investors to make bad decisions.

Today’s appetite for emerging markets could be dampened by reading Adam Smith’s immortal words:

“Little else is requisite to carry a state to the highest degree of affluence …but peace, easy taxes, and a tolerable administration of justice.”

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Comments

  • shamtest  On May 14, 2011 at 7:55 am

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    • Herve van Caloen  On May 17, 2011 at 8:24 am

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Trackbacks

  • By test blasts are fun on May 19, 2011 at 7:22 pm

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