classical economics
for analysis,  forecasting
and policy design

Policy Change
You Can Believe In

By Wayne Jett
© December 5, 2008

    In 1929, the Dow Jones Industrial Average made its high of 381 on September 3. Its low for the year of 198 came November 13, a drop of about 48%. The Dow’s all-time high of 14,198 (without correcting for inflation) occurred October 9, 2007. On November 21, 2008, the Dow’s intra-day low was 7,392, a drop of 48% from the peak. On November 4, a majority of Americans voted for change.
    What change? Most would say changed economic policies, not merely changed faces. Whatever policies caused the dollar to lose so much of its purchasing power during the past five years should be changed. Policies that caused or allowed prices of crude oil and gasoline to rise three times higher than two years ago should be changed. Policies that permitted trading practices in securities and derivatives markets to destroy major financial institutions and to frighten credit markets into a state of seizure ought to be changed.
    Abject failure to apply sound economic policies during the tenure of Henry M. Paulson Jr. as Secretary of the U. S. Treasury led to collapse of financial institutions and the economy, and to wholesale transfer of political leadership now underway. President Bush’s economic team, dominated by Paulson since July, 2006, included no one guided by economic principles different from Keynesian theories espoused by the Carter and Clinton administrations. Worse, Paulson pragmatically delivered whatever policy Wall Street interests desired to assist their stripping capital from investors, spendable income from consumers, and bailouts from taxpayers.
    The president-elect, Barack Obama, can succeed politically by climbing out of the economic hole dug during Paulson’s tenure at Treasury. But exchanging Paulson for Timothy Geithner as Treasury secretary will only dig the hole deeper unless policies change, too.
Stop Crude Oil Price Manipulation
    First, and easiest, Obama should immediately eliminate the dark market for trading crude oil futures and other derivatives, which enabled manipulators to push the world price of oil (and gasoline) to historic highs. Economic recovery cannot be sustained if they are left free to do it all again. Democratic rank-and-file in the House have legislation to do the job, and would have done it in July if Wall Street lobbyists had not blocked their way. Republican rank-and-file would lend support.
End Naked Short Selling, Deliver the Shares
    Second, Obama should tell the SEC he wants naked short selling of corporate securities stopped immediately in all U. S. financial markets. He should demand SEC enforcement of existing federal law that prohibits acceptance of money for sale of securities without concurrent delivery of securities sold. He should demand immediate buy-in of all presently undelivered shares for which sellers were paid, and stiff prison sentences for market manipulators who use naked shorting, wash sales, credit default swaps or any other tactic to drive share prices.
    Nothing done by Treasury or the Federal Reserve to restore credit markets or the economy can succeed while manipulators are given lawless trading conditions allowing any company to be attacked and destroyed. House rank-and-file Democrats led by Pete DeFazio of Oregon and Marcy Kaptur of Ohio preferred this action to the October bailout bill, and would eagerly put a good bill on the new president’s desk.
Void Credit Default Swaps
    Third, Obama should ask Congress to act promptly to enact legislation declaring void and unenforceable all credit default swaps and other derivative securities, except only to the extent such securities covered an insurable interest governed by state laws requiring adequate reserves at the time of issuance. In no circumstance should non-parties (i.e., American taxpayers) be required by the federal government to pay off “side bets” made by speculators on securities chosen for their likelihood of default.
Honest Dollar Policy
    Fourth, Obama should declare an “honest dollar” monetary policy that will no longer steal from workers the fair value of labor after they are paid. U. S. monetary policy is based on Keynesian theory of interest rates manipulated lower to subsidize production. Unfortunately, such subsidies produce inflation unless currency value is stabilized by monitoring liquidity flow. The Federal Reserve “fights inflation” by combining Keynesian ideas with Phillips Curve theory to justify raising interest rates to create higher unemployment. This Fed policy ended strong economic growth that followed cuts in tax rates adopted in May, 2003, and contributed to financial collapse in 2008.
    Both Federal Reserve and Treasury are now captives of their past policy errors. They have expended the full reach of money creation and borrowing powers to contain problems they parented. The New York Times tracks total commitments to bailouts in the form of loans ($1.7 trillion), investments ($3.0 trillion) and guarantees ($3.1 trillion) as $7.8 trillion. Most of this staggering sum is hoped to be, not spending in the traditional sense, but investment in financial assets that may return the funds, plus gains or minus losses. Husbanding these commitments towards a positive outcome will command full attention of the Fed and Treasury, leaving little attention or resources for new challenges.
    President-elect Obama needs policy changes that don’t cost money. In making selections, he should recall that the stock market low of 198 on November 13, 1929, after the Great Crash was not the bottom. The bottom was 41, a further loss of 79%, reached June 8, 1932. Two days earlier, June 6, President Hoover signed a monstrous income tax increase on all Americans retroactive to January 1. On June 8, the day the stock market bottomed, Franklin Roosevelt was nominated as Democratic candidate for president on an anti-tariff platform.
    Once elected, Roosevelt kept tariffs high and repeatedly raised taxes, and the Great Depression followed. That is not a template Obama should choose to replicate. ~