The Wall Street Journal, October 4,
The Trade and Tax Doomsday Clocks
By Donald L. Luskin
The nearby chart is an update of one I showed on this page
in early July. It depicts how the stock
market over the last year and a half has followed a path eerily similar to
that of 1937. This week corresponds on the chart to mid-August 1937, when
the cumulative effects of massive hikes in personal and corporate tax rates,
severe monetary tightening, and aggressive business-bashing by the Roosevelt
administration tipped the economy into the "depression inside the
Depression." From there, stocks were in for the longest and second-deepest
bear market in history.
Thankfully, we're not repeating all the mistakes of 1937.
But Congress and the Obama administration are flirting dangerously with one
of them by failing to extend the expiring low tax rates for all Americans.
What's worse, we're close to repeating the mother of all policy errors, the
one made not in 1937 but in 1930—the one that started the Great Depression.
We're on track to resurrect the 1930 Smoot-Hawley Tariff Act.
Let's start with taxes. If today's low rates expire at
year-end per current law, that would at a stroke reduce after-tax income for
every working American, the average reduction being 3.3% according to the
Tax Policy Center. Do the math: 94% of income goes to consumption, and
consumption is 70% of gross domestic product. All else being equal, if the
Bush tax cuts don't get extended, that's a 2.3% hit to 2011 GDP. That means
instant double-dip recession, starting at midnight, Dec. 31.
Why won't the Democrats who control both houses of
Congress switch off this doomsday clock? It's because Democratic leaders and
the Obama administration want to roll the dice for the sake of ideology, by
giving tax relief only to the middle class while letting rates rise for
higher earners. A growing number of Democratic dissidents have joined with
Republicans in insisting that, in this weak economy, it's more prudent that
relief be given to all Americans.
Some have even undergone a supply-side conversion.
Forty-seven Democrats have sent a letter to House Speaker Nancy Pelosi
citing the urgency of preserving low tax rates on dividends and capital
gains for the sake of more job-creating capital formation.
leaders blocked Congress from taking up the matter before the October
recess, fearing a humiliating defeat. Last Wednesday a resolution permitting
the House to adjourn without dealing with the doomsday clock passed by a
single vote, over unanimous Republican opposition and nays from 39
When a bill comes before the House in the lame-duck
session later this year, the games will really begin. House rules allow Mrs.
Pelosi, as speaker, to offer legislation under what's known as "suspension
of the rules," which limits time for debate but requires a two-thirds
majority to pass, rather than a simple majority. If Mrs. Pelosi offers a
bill under suspension that excludes the highest earners, there's little
chance she'll get enough GOP votes for the supermajority she needs. That way
she can blame Republicans for the defeat of an already doomed bill many
Democrats oppose, shaming the GOP for "voting against middle-class tax
Now to protectionism. Last week the House passed the
Currency Reform for Fair Trade Act. It's an amendment that gives dangerous
new protectionist powers to the notorious Smoot-Hawley Tariff Act, the
proximate cause of the global Great Depression, which after all these years
is still on the books. Democrats—all but five of whom voted in favor of the
bill last week—would do well to remember that in 1932 Franklin Delano
Roosevelt ran as a free-trader, pledging to lower Smoot-Hawley's tariff
walls. The 99 Republicans who voted aye should know that Herbert Hoover's
name lives in infamy for erecting them. Instead, Wednesday's vote was a
bipartisan move to build those walls higher using currencies as the bricks
The bill, if passed by the Senate and signed by the
president, would mandate that the Department of Commerce take a foreign
country's currency interventions into account in determining whether its
trading practices are unfair. In the case of China—the target at which this
bill is aimed—Commerce would determine that the amount by which the yuan is
allegedly undervalued. The number being thrown around now by supporters of
the bill, such as the AFL-CIO and the United Auto Workers, is as much as
40%. The cost basis of Chinese-made goods exported to the U.S. would then be
adjusted upward by that amount to determine whether they are being sold
below cost, an unfair trade practice known as "dumping." Not a single
Chinese export good could survive such a test—virtually the entire volume of
China's exports to the U.S. suddenly would become subject to countervailing
Surely China would retaliate. That makes the bill a
nuclear threat of mutual assured economic destruction. If carried out, it
would crush trade between China and the United States, which are huge export
markets for each other.
Suppose China blinks and revalues the yuan to avert the
nuclear threat. Even if this creates some American jobs, which is doubtful,
it would do so by making all Chinese goods more expensive in the U.S.—an
immediate inflationary tax on American consumers.
At the same time, it would make goods priced in dollars
cheaper for China to import, supposedly a boon to U.S. exports. But an
unintended consequence is that it will make China an even more voracious
competitor for oil. That's because oil is priced in dollars, so a
revaluation would make it cheaper in yuan terms. Remember, during the period
from 2005 to 2008 when the yuan was revalued under similar political
pressures from the U.S., the price of oil rose, not coincidentally, to $147
per barrel from $60. That could happen again—and it would be another
inflationary tax on U.S. consumers.
Both issues—extending today's low tax rates, and
protectionism against China—are animated by the coming election. Once that
has passed, presumably cooler heads on both sides of the aisle will prevail,
and these twin threats to our fragile economic recovery will fade away.
But sometimes such things can take on lives of their
own. And sometimes in the heat of politics cooler heads do not prevail. If
that happens now with issues as critical as these, then the economy and the
stock market will be doomed to repeat the tragedies of the 1930s.
Mr. Luskin is chief investment officer at Trend Macrolytics LLC.