Entries for August 2007

"Forget about 2007. It's all about the 2008 and the election," is how one veteran Capitol Hill watcher said I should think about all the upcoming goings-on and machinations in Congress. Both parties are trying to "prepare the battlefield" this fall to put themselves in the best position with voters come Election Day 2008.

The Republican presidential candidates seem to be assuming that their Democratic rivals are going to push for repeal of all the Bush tax cuts. That's why they are always talking about a potential $2 trillion-plus tax hike when those reductions expire at the end of 2010. More likely, Democrats will call for only the tax cuts on wealthier Americans to be repealed—such as raising the top rate from 35 percent to 40 percent—and for keeping most of the middle-class tax cuts, including rate reductions and a higher child tax credit.

I had a chance to chat with Rudy Giuliani this weekend, on Saturday morning, just after he finished with his "tax summit" campaign event in Manchester, N.H. There, Giuliani offered his case for making the Bush cuts permanent, killing the estate tax (or "death tax," as he puts it), indexing the alternative minimum tax to inflation, and lowering corporate taxes. The easy-reading, truncated version of the interview can be found here. But lucky CapCom readers get to peruse the longer "director's cut." No Iraq, no abortion, no immigration—just hardcore economic policy. Giuliani speaks at length about taxes, Social Security, and the mortgage crisis. But since you're likely to be Giuliani-ed out by the end, I am giving my analysis upfront. My takeaways are as follows:

The last politician who took advice from the bond market was Bill Clinton. When he pushed for a tax hike back in 1993 to cut the budget deficit, it was under the assumption that bond investors would respond by bringing down interest rates. (The theory here is that deficits are inflationary. Inflation is bad for bonds.) Yet long-term interest rates surged from 6.45 percent when Clinton signed his tax-hike bill on Aug. 10, 1993, to 8.16 percent on Nov. 7, 1994, the day before the midterm congressional election where Republicans won back the House and Senate.

Now PIMCO's Bill Gross, perhaps the most well-known bond fund manager in the world, is giving President Bush and the GOP some advice. He wants the government to start cutting checks to struggling homeowners, as both good policy and smart politics. (Bush has already ruled out any direct payments.) As Gross wrote in his recent letter to clients:

"I mean, what the hell was that?" was the puzzled reaction of one conservative activist to a recent interview with soon-to-be White House contender Fred Thompson, in which the Republican compared tax cuts to entitlement spending. Two others expressed similar puzzlement in recent chats with me. According to the Washington Post:

News that New Zealand's government is investigating clothing imports from China, including children's pajamas, after some were found to contain dangerous levels of formaldehyde is only the latest incident that has raised concerns about the safety of Chinese exports. About a month ago, I had a brief E-mail chat with Simon Anholt, a British government adviser specializing in the field of nation branding, about the impact of these product safety issues on the Chinese economy.

"More Americans making ends meet with less money," was the headline atop a Boston Globe story Tuesday morning. The newspaper went on to tell its readers that Americans in 2005 earned a smaller average income, when adjusted for inflation, than in 2000, $55,238 vs. $55, 714.

I don't have the storytelling chops of, say, Oliver Stone, but I'll do my best here: Last Thursday, the stock market was deep in the red all day, with the Dow trading down more than 300 points at its nadir because of investor fears about the mortgage credit crisis. Then as the session drew to a close, the stocks staged an amazing comeback. That huge deficit was nearly erased as the market finished with a miniscule 16-point loss for the day. Then on Friday, stocks soared after the Federal Reserve announced a surprise cut in the discount rate.

Now most traders attributed that Thursday comeback to rumors that Federal Reserve Chairman Ben Bernanke had seen enough and the central bank would take some action the next day. Others around the blogosphere had a different theory—make that "conspiracy theory." The Adventures of Citizen X blog wondered if the comeback was "a result of investors working through their worries (in a couple of hours no less) or government intervention?" The blog at Greenback Consulting, a stock trading firm, was also full of questions:

"Fed says 'no más,'" is how JPMorgan economist Bruce Kasman succinctly summed up the Federal Reserve's decision to cut the discount rate—the rate it charges banks on loans they receive from the Fed's so-called discount window—in his morning note to clients. And little wonder why: The whole global financial system seemed to be going a bit pear-shaped as the week ended. Even though Wall Street staged a late-day rally yesterday, Japan's benchmark Nikkei fell 5.4 percent overnight, its biggest drop in seven years.

"The hedge fund boys get in a little trouble and now you want the nanny state to come to the rescue?" is how economist Dean Baker, director of the Center for Economic and Policy Research, good-naturedly critiqued my recent call for the Federal Reserve to cut interest rates. Yet it's not just millionaire hedge fund managers taking a beating right now. Whenever the Dow tanks—as it's doing again today—America's broad investor class suffers, too.

Of course, it's not the Fed's role to protect investors—whether their money is socked away in hedge funds or 401(k)'s—from 10 percent market corrections. But one thing the Fed is supposed to do is prevent financial panic from dragging the economy into recession. Economist and CNBC host Larry Kudlow points out in a must-read blog post today that the huge drop in yields on supersafe three-month treasury bills—they're currently trading at a full percentage point lower than last week—is particularly ominous amid this spreading credit crunch. What does this all mean? Let me quote Kudlow at length:

It's terrible luck for Republican candidates in 2008 that just as the Iraq war seems to be ever so slightly turning for the better, the economy seems to be taking a turn for the worse, thanks to the spreading mortgage credit crisis. The former might not be decisive enough to save the party in 2008, while the latter might be just damaging enough to do it in for sure.

Wal-Mart stock got hammered today after the retailing giant cut its profit outlook for the rest of year, saying its customers were under "economic pressure." Now I can almost guarantee you that some congressman or think-tank economist somewhere is going to point to Wal-Mart's troubles (which many elites will delight in) as a worrisome symbol of growing income inequality, a sign that the company's supposedly lower middle-class customer base is getting left behind by the current economic expansion. A few thoughts on that:

I don't know whether the spreading damage from the subprime mortgage debacle will get anywhere bad enough to push the economy into recession. I doubt it, though. Today's data on consumer spending—sales rose 0.3 percent, core sales 0.5 percent—were encouraging, and many economists now think that the second-quarter gross domestic product number will be revised to perhaps as high as 4 percent from 3.4 percent.

So the "real economy" still looks pretty good even as the "financial economy"—Wall Street—looks a bit shaky right now. And don't forget that the global economy is booming. The International Monetary Fund recently raised its 2007 global GDP forecast to 5.2 percent. (It's not an overstatement to say that we are witnessing the greatest global economy in the history of mankind.)

"Bernanke needs to open the discount window—that's how bad things are out there...Open the darn Fed window!"

That's a choice hunk from CNBC's Jim Cramer now famous rant about the dangers that the subprime mortgage crisis poses to Wall Street and the need for the Federal Reserve to take action. But Cramer is far from alone. Here is my guy Ed Yardeni of Oak Associates—a guy who's been very bullish on the U.S. and global economies—in his morning economic note to clients: "The Fed needs to wake up. Perma-pause is over. It's time to ease. I think they will do so at the September 18 FOMC [Federal Open Market Committee] meeting, though probably sooner given how quickly credit conditions are seizing up." Actually, let's give Yardeni some length:

Many observers are concluding that new federal rules, which would require employers to fire workers with questionable Social Security numbers or face a fine, will do little to solve the illegal immigration problem. Count the Bush administration in that group. It seems likely that the White House is hoping that the outcry from an "enforcement only" approach to the issue— particularly from business—will force Congress to again take up comprehensive immigration reform and finally pass it. Consumers, too, may get more interested in the issue as they hear scare stories of farmers potentially unable to harvest their crops this autumn without the help of thousands of illegal workers. But what if the new Bush policy works? What if illegals, facing a greater chance of prosecution and reduced economic incentives to be here, start going home in droves? It could happen. A study by the Center for Immigration Studies found that after the Department of Homeland Security deported 1,500 illegal Pakistanis following 9/11, some 15,000 more illegal Pakistanis left the country on their own. And it's a lot tougher to get back to Pakistan than to Mexico and Central America. That is not the result Bush wants, but it could be the one he gets.