Fixing the economy is a matter of a few correct steps

I made a brief, flippant statement that simply making the Bush tax cuts permanent would get the economy back on track, and a negative comment on it cause me to clarify. My own comment got so detailed I think it deserves it own thread.

My basic point is:

We are in the tough economic situation because we are doing the wrong things, and all it takes to get out of the ditch is to start doing the right things. Those right things are not complicated nor unknown.

Let me clarify my statement:  I am not saying the recession can be averted now (it probably started in Q3), nor am I saying that we are not in serious economic straits. However, it really wouldnt be a challenge at all to get the economy back on track, if only we got our policies back on track.

And the #1 policy error of today is the threat to raise tax rates. A declaration to make the Bush tax cuts permanent would correct the #1 policy error of today.

Correct economic policies are not LIKELY in an Obama/Pelosi/Reid regime, but I think of it not being a challenge to know what those right policies are, we've known what the right policies are for decades, they've been tried and worked:

• Weak monetary policy led to the bubble and the bubble bursting, and a strong dollar policy from 2004 to today would have averted much of the crisis - we would have neer seen gold at $1000 or oil above $100/barrel, never seen the housing bubble and the consequent aftermath. The solution is to get back to sound money and strong dollar.
• On taxes, we must not estimate the huge magnitude of the tax increase, or the economy-deadening impact of letting such tax increases hang over us. They have killed business prospects for the future. Further, the asset values for everything - from commercial RE, housing, to stocks and bonds - are keyed off of future post-tax cash flow expectations. 2 days of post-Obama and the stock market loses 10% of its value, or about $1 trillion. Why? they know his higher taxes and other polices are harmful to the economy and will lower capital returns. We have had 2 years of Democrats in Congress threatening to raise taxes, passing tax increases, attacking business and CEOs. These attacks have toppled over the leveraged economy because the Dems policies have raised the price of risk capital (which you can see in the PE ratio changes from early 2007 to now). That price increase has killed highly leveraged investments. End the attacks and the threats of large tax increases by making the current tax system permanent, and the bloodbath of leverage investments ends too. That reverses the financial crunch, which is really a massive and global flight from risk.
• The recession we are in would not have been as severe without the oil price bubble. Prick the energy bubble permanently with pro-energy policies that increase domestic supply and reduce energy imports and you would prick on element that dragged down the economy.
• We have actually worsened the financial crisis with Government meddling and bailouts. These bailout costs harm our fiscal position, create a risk premium due to uncertainty in governments intervention (an example are the housing bailouts which by rewriting mortgages are in effect making new lending much riskier and less stable). End the bailouts, end the risk to contract law implicits in threats to rewrite bankruptcy law, and make moves to privatize Freddie and Fannie to end our huge liability exposure there.
• The fiscal situation - it's the spending stupid (or the stupid spending) that is causing deficits. Those deficits are not a short-term detriment to the economy, but impair our ability to manage monetary policy and control our long-term economic destiny.

I don't see Obama going in the right direction on taxes, spending, financial services regulations, or energy. (Nor do I have confidence Bernake will be a sound money guy.)

Since Obama's policies are the wrong things, we will remain in the ditch.

A simple declaration to make Bush tax cuts permanent would have an immediate positive effect right now because it would increase after-tax cash flow projections, enough to make risk capital come back in -  to an extent that would increase risk capital flows as much as or more than the $700 billion TARP bailout. Yet such a declaration costs nothing to the budget today and will pay for itself later. Similar ideas like the Eric Cantor's capital gains tax holiday or the proposal to cut corporate tax rates, which are too high, would be high positive cost-benefit as well.

In another blog, I mentioned the situation of the great depression. FDR did not in any way 'solve' the Great Depression, in fact if you read "FDRs Folly" and some recent economic studies, FDR's policies lengthen it. We speak of the Great Depression as a historic inevitability, but surely you can realize that nothing is inevitable. The great depression was caused by a combination of tariff increases (Smoot Hawley) and various beggar-thy-neighbor trade policies, tight money, and raising tax rates massively. Had FDR reversed these immediately, the economic history of the 1930s would have been much better. Indeed had Hoover never implemented them, there would be no Great Depression.

At this point, I am not talking about averting the recession, that's baked in to the 3rd and 4th Q, although it could have been averted with foresight by correcting the issues wrt taxes and oil prices in the past 18 months. The GNP grew by 3% in the 2nd quarter, we actually had growth up until then, despite the fact that the housing sector recession and bubble had burst 12 months prior.  When Reagan came in, he DID fix and turn around the economy, but we went through a tough recession to wring out inflation. In our current economy, we have a lot of deleveraging to digest; we have digested much of in wrt housing and corporate balance sheets are mostly okay (so long as we dont screw up things further). So even the right policies would have us go through a recession before we move on to better things.

But beyond a 2 to 3 quarter recession, in what way is continued economic misery inevitable? It is NOT!  what would be truly mind-boggling is to believe the lie that Govt policy doesnt impact the economy, or that higher or lower tax rates dont matter (they do). Dont be so superstitious or fatalistic to believe that economic misery under Obama is pre-ordained. It is not.the only thing that would make it inevitable is the inevitability of bad policies coming from Pelosi Reid and Obama led Government. It will merely be a consequence of his decisions and his policies.

PS. If you think a declaration to make the Bush tax cuts permanent is 'simplistic' consider how simplistic Paulsen's blank check was. 3 pages, and in the end the stated use of the money - to buy bad assets, was changed after the law was passed! Bottom line: If the issue is risk capital that is fleeing to the sidelines, you get it back in the investment pool by taking away external risks, and the #1 risk today is the risk of future tax increases.