Raymond Richman - Jesse Richman - Howard Richman
Richmans' Trade and Taxes Blog
Wall Street Journal's take on Bush economic mistakes
On Friday [Jan. 16, 2009], the Wall Street Journal editorial staff analyzed President Bush's economic mistakes (The Bush Economy) while completely ignoring two of them: (1) tolerating the foreign savings inflows that caused the trade deficits and (2) causing the stock buybacks that slowed economic growth.
Tolerating Foreign Savings Inflows
The Wall Street Journal begins by correctly pointing out that Bush inherited a recession when he took office in 2000:
Mr. Bush inherited a recession. The dot-com bubble had burst in 2000, and the economy was sinking even before the shock of 9/11, the corporate scandals and Sarbanes-Oxley....
He also inherited a growing trade deficit. During the late 1990s, when the bubble was occurring, foreigners were selling their currencies to buy dollars so that they could buy US stocks. As a result, they bid up the dollar and caused the US trade deficits to worsen, as shown in the graph below:
After 2002, the trade deficit would have fallen, but foreign central banks greatly increased their dollar reserve purchases so that they could keep the dollar high compared to their currencies. In the graph below, the US trade deficit (i.e., the current account deficit) is shown in red and the portion caused by foreign central banks is shown in green:
Bush and Greenspan did nothing to stop these increased foreign central bank dollar purchases. Greenspan could have easily counteracted them by buying the same amount of foreign currency reserves. Because he didn't do anything, net fixed investment in US manufacturing collapsed, as shown in the graph below, making American products less and less competitive in world markets:
The other effect of the foreign government reserve purchases was that they caused US long-term interest rates to fall, which contributed to the house price bubble. The Wall Street Journal blames these low interest rates on Greenspan's monetary policy. But Greenspan wasn't causing inflation.
His real mistake was that he, like the Wall Street Journal editorial staff, believed in the "free flow of capital ideology" which holds that the inflow of foreign capital is good for a country, even when it causes trade deficits. That's why neither he nor Bernanke nor the Bush administration did anything to counteract the inflow, even when it was deliberately being produced by foreign central banks, at the behest of their governments, in order to steal manufacturing market share from American producers.
The main central bank to follow this strategy was the People's Bank of China. The Bush administration never counteracted their successful attempts to manipulate their currency and ours in order to steal market share from American manufacturers.
Causing Stock Buybacks with a Capital Gains Tax Cut
The Bush administration's record is not entirely negative. They did do a good job with a tax cut in 2003 that helped the economy recover from a recession. The Wall Street Journal editorial notes:
This time the tax rate reductions were immediate, and they included cuts in capital gains and dividends designed to spur business incentives. As the tax cuts became law in late May 2003, the recovery began in earnest. Growth averaged nearly 4% over the next three years, the jobless rate fell from 6.3% in June 2003 to 4.4% in October 2006, and real wages began to grow despite rising food and energy prices. The 2003 tax cut was the high point of Bush economic policy.
Indeed, Bush's tax cuts provided the short-term stimulus which got the economy out of the recession. Unfortunately, the capital gains tax cut part of the stimulus severely hurt the economy in the long-term. Capital gains tax cuts increase tax revenue because investors take advantage of them to cash in and consume their capital.
Investors always face the choice of whether or not to keep their capital invested in order to earn the future income. When capital gains tax rates fall, as they did in 2003, investors are more likely to choose present consumption over future income. When they cash-in their wealth, aggregate demand temporarily increases while future income permanently decreases.
After 2003, Corporate managers, especially, cashed in their companies' wealth through stock buybacks. They would have their companies borrow at the cheap interest rates produced by the foreign savings inflow and use the borrowed money to buyback their own stock. They gave themselves stock options and then bid up their own companies stock price through stock buybacks. In this way they took advantage of Bush's 15% capital gains tax rate, as compared to the 35% tax rate they would have had to pay if they had received salary bonuses.
In all, from 2004 through 2007, America’s 500 largest corporations earned $2,505 billion while spending $1,578 billion on buybacks and $853 billion on dividends, leaving only $84 billion of their profits for reinvestment and corporate income taxes. The increase in stock buybacks began immediately after the 2003 capital gains tax cut, as shown below:
When the financial crisis hit in 2008, the very same corporations that were coming to the government for help had been depleting their corporate reserves through buybacks.
[Note: We recommend the rollover tax treatment for capital gains: High tax rate when capital consumed, but taxation deferred when capital rolled-over from one asset to another.]
Bush Administration's Failures in 2008
At the end of their editorial, the Wall Street Journal blames the Bush administration for the fact that their February 2008 stimulus package and October 2008 TARP bill did not turn around the economy. They argue that if these stimulus packages had been different in their composition or if they had been timed differently, they would have worked.
But these stimulus packages completely failed to address the real cause of the current recession: The American consumer could not continue borrowing more and more money to pay for the trade deficits. As the economics analysis of the Levy Economics Institute of Bard College makes clear, no stimulus package will end this recession unless the trade deficits are also addressed.
In an May 15 commentary, we summarized Bush's economic mistakes with the following words:
There are four major Republican economic ideas. Two of them work and two of them don't. Unfortunately, President Bush chose the two that don't work, and that is the reason for the current U.S. economic stagnation. These two Republican economic ideas work:
1. Reduce the size of U.S. government.
2. Cut business taxes.
These two Republican economic ideas don't work:
1. Cut capital gains taxes.
2. Welcome foreign investment that costs jobs.
The Republican Party has lost the Presidency, the House, and the Senate because of President Bush's economic mistakes. It is ill-served when the Wall Street Journal ignores those mistakes.
[This was originally posted on Jan. 19, 2009 on our old blog.]
Journal of Economic Literature:
Atlantic Economic Journal: