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The Daily Reckoning | Thursday, June 24, 2010 Stimulus vs. Austerity...and other centrally-planned misadventures, "Greedy industrialists" score one over ousted Aussie PM, Plus, Bill Bonner on those terrible housing numbers and the end of the recovery than never truly began... What Will Become of the Australian Mining Tax? Awaiting the response of the new Prime Minister Joel Bowman Reporting from Taipei, Taiwan... "It's a great day for redheads," Australia's new Prime Minister, Julia Gillard, is said to have proclaimed after her predecessor, Kevin Rudd, was ousted from the nation's top job yesterday. Your editor has nothing against redheads...but he had hoped the new PM would have more pressing issues on her mind than hair color. She is, after all, replacing a fellow Labor Party member who suffered one of the most precipitous popularity declines in Australian political history. The Rudd government, which came to power in a landslide victory back in 2007, soared to a popularity peak of 74% just last year. But when all was said and done, "K-Rudd," as his dwindling group of acolytes better knew him, didn't even last a full (3-year) term. Although Mr. Rudd's follies were many and varied, perhaps the leading catalyst for his political demise was his inept handling of the Resource Super Profits Tax. Without going into too much detail, Rudd had been pushing for a crushing 40% tax hike on top end profits for Australia's most successful industry - the mining industry. Unsurprisingly, this didn't go over well with the nation's producers, considered by most to be the engine room of the country's economic growth. The story is a classic "producer vs. parasite" tale, as our Reckoner-in Chief, Bill Bonner, might phrase it. Rudd, like any other socialist bully would do, attempted to sell the tax to the Australian public under the familiar "fair share" slogan. "The infrastructure needs of this state are vast and on the existing tax base cannot be funded," he told Australian reporters while on a recent visit to Western Australia, the nation's largest mining state. "We say the sector of the economy most able to share a greater part of the burden for funding our infrastructure needs for the future is in fact our most profitable mining companies." If this sounds like thinly veiled Marxist rhetoric, that's because it is. As the founder of that ill fated, though persistently insidious ideology himself famously noted: "From each according to his ability, to each according to his need." At least the miners themselves had the good sense to call it as they saw it. Andrew "Twiggy" Forrest, chief of Fortescue Metals Group, must have cut a Hank Rearden-like figure when he rallied his troops from the back of a flat bed truck on the same day Rudd visited the Great Western State. "In China right now there's a fierce debate about how to lower their resources tax to encourage the mining industry," announced Mr. Forrest. Australia, he said, was doing the exact opposite. "I ask you," he bellowed, "which communist is turning capitalist and which capitalist is turning communist?" Protesters attending the rally held up placards and chanted, "super tax, super stupid," "super tax kills jobs" and "Rudd's mining tax hurts us all." After meeting with the then-PM later that day, Mr. Forrest told the nation's mining community - including 30,000 of his own employees, many of whose jobs the proposed tax put in serious jeopardy - that he and Rudd had "nothing more to talk about." Now that Rudd has been dumped, that statement is truer than ever. Your editor certainly doesn't expect that the new prime minister will do any better, of course (she is expected to remain loyal to the very tax that saw to Rudd's eventual undoing, for instance), but in a world where parasites are sprouting like mushrooms in a dung heap, we "greedy industrialists" must take our victories when and where we can get them. Unfortunately, the "producer vs. parasite" battle is not confined to Australia. It rages on, all across the developed world. You can barely take your hands out of your pockets to light a cigarette without some greedy socialist spendthrift going for your wallet. Their spending is all for "the greater good," we are told, and to sure up that "still fragile recovery" we've been hearing so much about. But in the end, their central philosophy still hinges on the assumption that a small group of enlightened politicians can spend individuals' hard-earned money better than they can. Invariably, this arrogant assumption ends in tears. In this case, thankfully, those tears belonged to Mr. Rudd. In today's column, guest essayist Nathan Lewis explains why "less is always more" when it comes to government handling of the economy.  The Daily Reckoning Presents Stimulus, Austerity, and the Spiral of Decline Nathan Lewis In an economic decline, mediocre governments typically bounce back and forth between "stimulus" and "austerity." They are the ketchup and mustard of bad recession policy. "Stimulus" - favored by the left-leaning politicians - rarely amounts to more than a form of welfare spending. This is appreciated in hard times, but it tends to be extremely expensive and does little for the economy as a whole. Deficit worries increase. Then comes the "austerity," often favored by conservative politicians. "Austerity" usually means spending cuts and tax hikes. But, it does not take long before politicians, bureaucrats, public employees and corporate cronies all agree that they don't actually want to cut spending. Usually, they take some unpleasant swipes at welfare programs and services - in other words, the only programs that actually do some good, and which are especially important in a recession. This also happens to be the only government expenditure that does not land in the pockets of politicians, bureaucrats, public employees and corporate cronies. These spending cuts rarely amount to much, so the government relies more and more on tax hikes for their "austerity" plans. The results of the tax hikes are typically an even worse economy, and often no appreciable increase in tax revenue. As the economy contracts further, demands on the government increase. "Austerity" becomes unpopular, and is postponed until some future date "after the economy recovers." (The tax hikes remain, however.) If the government has not exceeded its debt carrying capacity, it lurches back toward "stimulus" and large deficits. Japan has been though this cycle probably a half-dozen times by now. If the government can no longer credibly issue debt, the typical next step is a double helping of "austerity." There is talk of huge spending cuts, which rarely materialize. What usually happens next is minor spending cuts and huge tax hikes. This often begins the final implosion, when businesses give up completely, and tax evasion soars as the government has lost all legitimacy. Default may follow soon after. Britain's government is near this point now. "Stimulus" is no longer tenable. Out come the tax hikes. The talk now is of raising the capital gains tax from 18% to 40%, and even 50% in some situations. This would be on top of an increase in the VAT to around 20% from 17.5%. It was 15% in 2009. In November 2008, Britain's government raised the top income tax rate from 40% to 45%, and in 2009 it increased to 50%. In his 1932 election campaign, Herbert Hoover boasted that more public works had been built in the four years of his administration than in the previous thirty. Federal spending ballooned from $2.9 billion in 1929 to $4.4 billion in 1931, a 52% increase. Part of this gusher of cash went to build the Hoover Dam on the Colorado River. This spending binge, in the midst of recession, brought huge deficits. Hoover then tried to address the deficit with a huge tax hike. In 1932, the top income tax rate in the US rose from 25% to 63%. He also tried to implement a national sales tax, but this was defeated. This followed the infamous Smoot-Hawley Tariff of 1930, which put a 60% tariff on more than 3,200 products. After 1933, the Roosevelt administration pursued much the same approach. By 1935, Federal expenditures had grown to $6.4 billion, and in 1940 they hit $9.5 billion - over three times the level in 1929. That year, the top personal income tax rate was 79%. President Roosevelt's Treasury Secretary, Henry Morgenthau, described the results in May 1939: "We have tried spending money. We are spending more than we have ever spent before and it does not work. ...We have never made good on our promises... I say after eight years of this Administration we have just as much unemployment as when we started... And an enormous debt to boot." The cycle of "stimulus" and "austerity" eventually leads to more spending and higher taxes. It doesn't work. So what's the solution? A better strategy is less spending and lower taxes. In 1976, Britain was so hard up that it had to go to the IMF for a loan. Without this assistance, the government would have likely defaulted. The IMF insisted on its usual "austerity" plan, with spending reductions and higher taxes of course. In 1979, Margaret Thatcher became prime minister. Thatcher is remembered today for her sweeping reorganization of government, in which public employees, subsidies and state-run businesses were slashed or discarded. She crushed the influence of public unions in the face of widespread strikes. Despite this, in the 1983 general elections, only 39% of union members voted for the opposing Labor Party. Thatcher was popular. Why? The other side of her strategy was tax cuts. She immediately moved to lower top income tax rates from 83% to 60%. By 1986, the top income tax rate was 40%, and the basic rate had fallen to 25%. Capital gains tax rates were reduced from 75% to 30%, and indexed to inflation. The corporate tax rate was reduced from 52% to 35%. Ronald Reagan, in the US, had much the same strategy: tax cuts and spending cuts. During his presidency, the top US income tax rate fell from 70% to 28%. His attempts to reduce spending floundered in the Democrat-controlled Congress. Ideally, spending reductions should focus on the waste, theft and graft - the politicians, bureaucrats, public employees and corporate cronies - not on the public services which are the government's primary reason for existence. Britain still has its National Health system. I find that these sorts of policies are accompanied by a certain change in mood. The political focus shifts from parasitic self-enrichment to one of national success and failure. If your initial premise is to find a way to strip-mine the populace for wealth, and then distribute your gains among your cronies, then tax hikes and spending increases are the natural conclusion. Politicians find the answers when they start to ask the questions. Thatcher studied conservative texts, and actually read Friedrich Hayek's The Road to Serfdom from cover to cover. You can sense this change in mood when the terms "stimulus" and "austerity" disappear from discussion. Politicians start to talk about "national greatness," as Vladimir Putin did in 2000 when he introduced Russia's amazing 13% flat income tax. In the explosive recovery that followed, the Russian government's income tax revenues soared. In 2001, the first year of the new tax system, income tax revenues increased by an astonishing 46%! This had nothing to do with oil prices, which finished that year at $19.33 per barrel. In 2002, income tax revenues increased another 40%, and crude oil finished the year at $29.42. By 2007, income tax revenues were 624% higher than they were in 2000, and Russia was once again a major world power. This can be a wonderful time for investors. Sometimes, governments never pull out of their spiral of decline. During the 16th century, Spain was the wealthiest and most powerful state in Europe, with a world empire stretching from California and Peru in the west to the Philippines in the east - not to mention Portugal and most of Italy and the Netherlands. By the early 17th century, native Spaniards were fleeing to the Americas to escape crushing taxes. In his wonderful book, For Good and Evil: the Impact of Taxes on the Course of Civilization, Charles Adams notes an observer in early 17th century Madrid who said: "The galleons left on the 28th of last month; I am assured that in addition to the persons who sailed for business reasons, more than 6,000 Spaniards have passed over to America for the simple reason that they cannot live in Spain." Four hundred years later, Spain remains a nice place for a sunny vacation. Nathan Lewis, for The Daily Reckoning Joel's Note: Nathan Lewis was formerly the chief international economist of a leading economic forecasting firm. He now works for an asset management company based in New York. Lewis has written for The Financial Times, The Wall Street Journal Asia, The Japan Times, Pravda, and authored Gold: The Once and Future Money. Bill Bonner Economic Stimulus Can't Stop De- Leveraging Bill Bonner Reckoning from Baltimore, Maryland... You say yes, I say no You say stop and I say go, go, go Oh, no - The Beatles We keep saying the same thing here at The Daily Reckoning. Not because we lack imagination... It's because things are still the same. "Outlook for home prices grows darker," says The Wall Street Journal. Well, yes. Much darker. Bloomberg: Sales of US New Houses Plunge to Record Low as Credit Ends June 23 (Bloomberg) - Purchases of US new homes fell in May to the lowest level on record after a tax credit expired, showing the market remains dependent on government support. Sales collapsed an unprecedented 33 percent from April to an annual pace of 300,000, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down. Exceeds Drop Projected Sales were projected to drop 19 percent to a 410,000 annual pace, according to the median estimate of 76 economists surveyed. Forecasts ranged from 300,000 to 530,000. The government revised April's purchase rate down to 446,000 from a previously reported 504,000. Hey, what happened to that $12 trillion worth of stimulus spending, guarantees and bailouts? We said it wouldn't work from the get-go. They said 'yes, it will.' We said 'no, it won't.' Can we have our money back? Last week's report showed that used or existing houses were not selling. Now we find that new houses are selling even worse. The tax credit doesn't really expire until the end of this month. But you can't build a new house in 4 weeks, so the May new house data reflects the end of the credit. You've heard the expression, 'bad money after good'? Well, stimulus money was bad money from the beginning. It headed down the drain the minute it left the bank. Trillions of dollars wasted. And for what? That's the interesting thing. The feds couldn't really stop the process of de-leveraging. They could make-believe...with federal spending projects that looked a little like real work...and handouts that looked like real income. But all they could really do was rob Peter to pay off Paul...or rip off them both with debts they couldn't pay and phony money they couldn't back with anything real. All they did was make sure some people were hurt worse than others. Shareholders, for example, lost trillions as stocks fell. The market has recovered much of the loss, but US stock market investors are still out more than $3 trillion. Homeowners lost big, too. Clip 20% to 50% off the value of America's housing stock and you've erased as much as $10 trillion. We don't know yet. The housing market moves slowly. It discovers what things are worth...but only by fits and starts. After the latest housing news, our guess is that house buyers are going to squeeze their nickels even harder. And house sellers are going to be even more desperate. Between the reluctance of the buyers and the eagerness of the sellers, house prices will probably come down another 10% to 20% - maybe more - before they finally reach bottom. But thanks to the generosity or stupidity of the US government, bondholders have done pretty well. Instead of letting the whole capital structure collapse, so that it might be rebuilt on a more solid foundation, the feds bailed out the bondholders...who just happen to be very cozy with Wall Streets big banks and federal authorities. Then, of course, the feds congratulated themselves. They avoided a disaster. They saved the world. They brought the world economy back from the brink of catastrophe. At least that is how they and the press spun the story. For our part, we would have preferred to see the whole thing go over the edge. Not that we know what kind of catastrophe would have resulted. But we wanted to find out. And whatever it was, we doubt that it would have cost $12 trillion. In fact, the price would have probably been only a fraction of that amount... For every bondholder who would have taken a loss there was a debtor somewhere who would have been relieved of a burden he couldn't pay. In the present case, the debtor was relieved of his burden. The feds took it over from him. Now, it's on all our backs! And more thoughts... Yesterday, we went over to Mondawmin Mall to renew a driver's license. Mondawmin is in a part of Baltimore that is 100% black. We drove by abandoned wrecks...and some tidy neighborhoods with attractive row houses. Blacks seem to have disappeared in America. In the '60s and '70s, they were the center of attention. How come they hadn't integrated better, people wanted to know? How come there was such an income gap? What kind of racism still lurked in American society and how could we get rid of it? But then, Barack Obama was elected. Now, no one seems interested in racism...or in blacks. 'If a black man can be elected president, the rest of the them can stop their bellyaching,' people seem to say. 'If they don't succeed, it's their own damned fault.' At least, that seems to be the temper of the times. Instead, the media seems more interested in Hispanics. One of them is shot dead at the border. A town passes a law preventing illegal immigrants from working. The great state of Arizona reserves the right to ask for their papers at any moment. "Are you a citizen?" says the policeman. "Prove it." Blacks and whites have been zombified. The brown man has not. Blacks and whites have the right papers. They get their checks, and their free food, and their government jobs. They carry the phone number of a tort lawyer in their pocket and hope someone hits them. Illegal aliens are practically the only real Americans left. They don't have any contact with the zombie administration. (We don't know that this is true, by the way...we're just imagining...) They don't register to vote...or to get food stamps...and they don't complain when their employers harass them. They're afraid of being deported! But back in the Mondawmin Mall the clerks were black, the customers of the Maryland Department of Transportation were black. Everyone was black but your editor. Of course, your editor grew up in the tobacco fields. In some ways, he is probably more black than most of the blacks at the mall, even though he is lilywhite. Our father came from an Irish family; they were fairly recent immigrants from Donegal. But our mother's family had been in Tidewater Maryland since the reign of Queen Anne. Families - black and white - that have been in southern Maryland for 3 centuries are almost all related to each other. When we were growing up, a distant cousin, Geoffrey, lived across the road in a tenant shack. We weren't supposed to know or mention that he was a cousin. He was black. But Geoffrey grew up, went to medical school and became a doctor, now practicing in North Carolina. We're probably as big an embarrassment to him now as he was to us then. Later, we moved to a Baltimore inner city. It was the lure of architecture that led us thither - big beautiful houses built by Jews in the 19th century. We bought one in 1983 for $27,000. We fixed it up and lived there for 10 years. One of our favorite neighbors went by the name, Simms. That he had a first name or a last one, we were sure. What they were we never discovered. Simms was reliable. He would get rip-roaring drunk every Saturday night. In warm weather, he would get together a group of cronies and sit on the stoop and sing. "You are sooooo beautiful..." was one of his favorites. As he got drunker and drunker he would forget more and more of the words. 'You are so beautiful' was all he was left with at the end. Then, he'd fall dead asleep in a wheelbarrow so it was easy to cart him out of the way. But in the '80s the inner city didn't get better. It got worse. And when our children started growing up, we realized that we couldn't let them out on the streets. It was too dangerous. So we moved out. The people in the Mondawmin Mall were all polite. We wouldn't say that they were efficient. Efficiency did not seem to be something they were interested in. Many were probably unemployed or marginally employed. Time is not that precious when you are out of work. A process that should have taken 5 minutes dragged out for an hour. The young men all seemed to have tattoos...and pants down below their derrieres. One had to pull up his pants to keep them from falling around his ankles. The women often had tattoos too. Almost all the women over the age of 25 were huge. Many had clothing styles and hairstyles that your editor had never seen before. We took a number and sat down. From what we could figure there were 157 people waiting ahead of us. Another number was called every minute or so. It was going to be a long wait. Next to us sat a big man who looked like he might be a bricklayer or a mover. He was sturdy...with thick legs and arms. On the other side, a woman and her daughter kept up a conversation. The daughter was there to get a learner's permit. Their accents were so strong, we had a hard time following the conversation. These were not Southern Maryland blacks. These were Baltimore ghetto blacks with an accent of their own. Mother: "Get off dat phone...you bin talkin' all afternoon." Daughter: "I'm talkin' to daddy." Mother: "Well, tell that son of a b*** to give me some money." Daughter: "You gonna haf to tell him dat yosef." Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com Advantage, Emerging Markets Almost all the developed countries are headed for crises, collapse, and used-to-be status. Their debt is still rising. They have made promises to retirees that can’t be kept. They have expenses they can’t meet...an aging population...uncompetitive industries...and zombies on every street corner. Who has the money? Well, the biggest piles of it are in the hands of Asian nations. Economic Recovery Awaits the Housing Market Correction Correction Turns “Great” Thanks to Government Intervention Euro Declines on a Sea of Bankruptcy and Paper Promises Do you ever get the feeling that you are in some kind of weird dream, where someone is holding a pillow over your face so that you can’t breathe, and you can dimly hear your children asking, “Is he dead yet, mom?” and I am thrashing around and yelling out, “No, I’m not dead, you morons!” but nobody is paying attention? Me, too! The Correlation Between Morons and Government Debt Insufficient Silver to Supply China’s Growing Demand Socialism, Roman Style The role of money in Roman credit crises can be carefully examined. The recurrence of credit panics on the surface seems incongruent with the discipline of hard money developed in the Roman Republic. But as a reserve, silver expanded geometrically, acting as a rudimentary version of today’s fiat backing, and its production was under complete government control in state-owned mines... Failed Federal Budget Means Middle-Class Tax Hike Likely Biggest Manufacturer Since 1890s, US Now Slipping Behind China