Image“Dow dives 370 points on recession worries” was a headline I saw this week. It resembled many in recent months, as the stock market zooms up, then crashes down, often by hundreds of points. In October 2006 the Dow Jones Industrials closed over 14,000 on several days. Since that time, it has slid precipitously, finally crashing to 12,000 in January. Although the DJIA has sometimes regained as much as 1000 points since that low point, it quickly retreats again to hover near 12,000. Why is that? And what does it all mean?

Market “experts” give us technical details, almost daily, to explain why the market has risen or fallen: e.g., the Fed has not lowered interest rates; or the Fed has lowered rates, but Wall Street doesn’t think it was enough; or Microsoft profits were lower than anticipated; or retail profits were better than expected; or the market is worried about new housing starts; or wicker-furniture profits are up in Bora Bora; or rickshaw commerce has hit a rough patch; etc.

These analyses may have some validity – and they are certainly factual – but they cannot really explain the market’s extreme nervousness. Two weeks ago the Fed lowered interest rates by 75 basis points in an “emergency” action. The market rallied briefly, then crashed through its opening mark to lose 60 or 70 points for the day. The next day it rallied back hundreds of points. It lurches to and fro like a drunken man. What could all this possibly mean?

We sometimes do hear that investors are worried about a possible recession in the near future. But the Great Unmentionable remains, well… unmentioned. Only rarely do we hear that investors are nervous about the future because the current presidential campaign might produce a president who advocates higher taxes, more regulation, a less-free market, and more government control of business, the news media, and the economy.

In truth, the American economy has not seen such a president for 28 years. An entire generation has grown up blessedly unacquainted with high income tax rates, high inflation, high unemployment, the Fairness Doctrine (that effectively eliminated on-air political discussion), and a stock market that stayed flat for 14 years (e.g., 1967-1981).

Since 1980, the Gross Domestic Product has gone from $2.8 trillion to $14 trillion – a fivefold increase (unadjusted for inflation) that amounts to an average 6% annual increase. During that era we had Ronald Reagan, George H. W. Bush, Bill Clinton and George W. Bush. Mr. Reagan championed historic tax cuts and boosted the economy into high gear. Mr. Bush (41) stumbled slightly by agreeing to higher tax rates, which (arguably) cost him a second term. Mr. Bush (43) made sure not to repeat dad’s error. Lower taxes were Job 1 on his agenda.

Mr. Clinton ran as a “New Democrat” – which translated somewhat uncertainly into actual policy – but he was smart enough not to mess with the economy very much. His signature campaign slogan in 1992 was that Mr. Bush (41) had given us the “worst economy since the Great Depression”. The claim was risible, but it had just enough cachet with young people who didn’t know better to let him slip into the White House (with Ross Perot’s help).

Clinton economists began backpedaling on the “poor” economy story as soon as he took office. The post-Desert Storm recession was very shallow. Essentially, the Reagan economic “miracle” roared on, virtually without pause, until the terrorist attacks of 9/11/2001 put the brakes on.

Experienced businesspeople can adapt. They can deal with low taxes (preferred, of course) and with high taxes – with more regulation, or with less – with more government, or less. But they get most uneasy over uncertainty. They have trouble dealing with not knowing how it’s going to be. When the business environment is uncertain, investors become nervous. They try to sell out fast when they see the market going down. Or they try to jump on the bandwagon when they sense that things are going back up. This subjects the market to wild swings like we’re seeing now.

One might reasonably assume that presidents and congressmen – of any political stripe – would want to keep investor uncertainty to a minimum, to avoid roiling the markets unnecessarily. But one would be wrong. Indeed, a disinterested observer might conclude that the precise opposite is true. This is close to the mark. From long experience, congressmen know that presidents usually get blamed for jittery or crashed markets, but Congress, almost never. Thus, when the president is not of their party, some congressmen try to block policies that might calm the stock market or cause it to leap ahead. This, they know, will probably hurt the president, politically – never a bad thing in the political calculus. The country’s well-being takes a back seat to politics in such cases.

To validate this premise, one need look no farther than the so-called Bush Tax Cuts – enacted in 2001 and 2003 under arcane congressional rules specifying a sunset date of December 31, 2010. According to Heritage Foundation analysts William W. Beach and Rea S. Hederman, Jr., a failure to make the cuts permanent will produce the following direct results:

  • Tax rates will rise substantially in each tax bracket, some by 450 basis points;

  • Low-income taxpayers will see the 10-percent tax bracket disappear, and they will have to pay taxes at the 15-percent rate;

  • Married taxpayers will see the marriage penalty return;

  • Taxpayers with children will lose 50 percent of their child tax credits;

  • Taxes on dividends will increase beginning on January 1, 2009;

  • Taxes on capital gains will increase, also beginning on January 1, 2009;

  • Federal death taxes will come back to life in 2011, after fading down to nothing in 2010.

Mr. Beach and Mr. Hederman detail the likely economic advantages of making the cuts permanent, as well as the serious effects of letting them expire. [1] The opposite-party dynamic is plausible now, with a Democratic majority in both houses of Congress, but Republicans held both houses from 2002-’06. Somehow, in four years they could not get around to making those cuts permanent. Why they couldn’t is a topic for another discussion.

The point is that the closer we get to the various “pumpkin” dates, the more jittery businesspeople and investors are likely to become. The stock market’s roller-coaster act of the last few months is only the start of a wild ride that could actually trigger The Big One – market insiders’ name for the earthquake that could crash the market by 50%.

Do Democrats welcome a market tsunami that will destroy Bushism and usher them, at long last, into the “promised land” of political power? Maybe some do, but others seem less sure if “destroying the economy in order to save it” is really such a good idea. A recent Washington Times report noted that Democratic presidential candidate Hillary Clinton has quietly retreated from Democrats’ much-trumpeted idea of letting the (hated) Bush tax cuts die an ignominious death. She is on the record as saying that only the marginal rates in the two highest income brackets should be increased – and then only after the economy is well past any recession.

Maybe The Big One doesn’t sound as interesting or fun if you think you might be sitting in the Oval Office when the crash happens. Although this new “epiphany” is undoubtedly motivated by political self-interest on Mrs. Clinton’s part, maybe it’s possible that she is actually moving toward something like “statesmanship”. (Or is that stateswomanship?) Stranger things have happened. Maybe there’s hope for the country yet.

*******

[1] See the Beach/Hederman article, “Make the Bush Tax Cuts Permanent”, at http://www.heritage.org/Research/Taxes/wm956.cfm