Foresight: A Tool, Not A Trick

*** NOTE: After finishing my finals today, I'll be sure to keep the posts coming on a more regular basis. ***

There is one fundamental difference in how liberals and conservatives handle economic issues. Conservatives value foresight as tool while liberals view everything through its short-run effects. While studying for my history final, I read a section on the Reagan tax cuts in 1981 which seemingly caused an economic downturn, according to the book's author. There is an economic tool that conservative supply-siders use to discourage this notion.

Economic policies tend to have a lag effect. For example, a tax cut will cause consumers to act as though they have more money when in reality they won't until at least the following year. Increased consumption and demand in domestic markets leads to price inflation. So immediately following a tax cut, the short-run effect is inflation. In the long-run, however, tax cuts increase output and bring prices down. Several years following Reagan's tax cuts, inflation and unemployment dropped drastically, but nobody understood exactly why. That, ladies and gentlemen, is the lag effect.

The lag effect is a prime example of the benefits inherent in foresight. A good economist knows both short-run and long-run policy implications. Short-run thinking leads to reactionary policies that keep the economy on a see-saw pattern of expansion and recession. Long-run thinking smooths the crests and valleys caused by the business cycle. Liberals often make the mistake of seeing benefits in the immediate future while overlooking the obvious long-run implications. For example, medicare and social security are headed for insolvency in the very near future. They see any solution as having a negative effect on current recipients but they choose to ignore the long-run implications of doing nothing.

Short-run thinking often wins elections, which is exactly why it is so alluring. If a politician can pursue a policy that has very visible positive effects in a short period during election season, they can trumpet their success during the campaign. Nobody notices the implications five years down the road when the same politician is championing a solution to the problem they caused. This is one of the biggest reasons that we need term limits in Congress. A politician with no option for re-election will find it much easier to adopt a long-run philosophy.

Wall Street's Bull Run Continues

Several months ago, the majority of financial commentators were sounding the death knell for Wall Street's historic three-plus year rally. Between then and the time the second round of Bush tax cuts went into effect (May 2003), the blue-chip Dow Jones Industrial Average (DJIA) had soared 47%. Yet many in the financial community as well as naysaying pundits on America's editorial pages were calling for a stock market correction (when an exchange or index loses 10% or more of its value in a short period of time) and an economic recession. The popular question of Dow 9,000 or 12,000 was met by the resounding reply of "NINE THOUSAND!!"

And back to the present ...

The DJIA is now setting records that seem to come day after day, week after week. At its intraday record value of 13,256 the blue-chip index is at a 60% premium from its May 2003 low. In the last month, the DJIA has gained on 21 of 24 sessions with the total amounting to a 7.4% gain, its best winning streak since 1955 when it gained 10% on 22 of 25 up sessions. On top of that, the tech-heavy NASDAQ is at a 6 year high and the S&P 500, an index of the 500 largest companies, is at a 6-1/2 year high.

The economy is hitting on all cylinders as well, trouncing all calls for an oncoming recession. After a year and a half of interest rate hikes by the Federal Reserve, inflation is moderating and any signs of economic weakness are becoming signs of economic stability. What was said to be a housing bubble has turned out to be nothing more than a valley. Even a crisis in the subprime lending industry hasn't seeped into the robust economy, but has been contained to the already hampered housing industry. Put another one in the "wrong" column for the pessimists.

Clinton had the tech boom to grant him a roaring economy for his first seven years in the White House. In 2000, the tech bubble and stock market crash left the economy in a downward spiral when George Bush took over. In only his eighth month, the despair was compounded by 9/11. But after the 2001 tax cuts staunched the bleeding, the road to recovery was short and robust growth was restored with the 2003 tax cuts. After all of this, Clinton gets the praise while Bush is looked upon as a foolish failure. Sounds like someone has their facts mixed up ...