February 4, 2011

This weekend, many will celebrate the 100th birthday of Ronald Reagan. Only a handful of individuals really change the world in one's life time. Ronald Reagan was one of them. His legacy will be twofold. Not only did he defeat the Soviet Union without a shot being fired, he also created an economic strategy so powerful that it took the nation from crisis to prosperity. It was an economic policy which aptly became known as Reaganomics. To accomplish this he had to create what amounted to a revolution.

Reagan once said in regards to his administration and policies, "You know, we're all a bunch of radicals up here." Reaganomics was a program based on four pillars: dramatically reduced tax rates, sound monetary policy, deregulation, and increased free trade. It's hard to comprehend how bad things were back in 1980 when Ronald Reagan took over the Presidency. The US was in the middle of a terrible recession with unemployment over 10%, inflation at 12%, and long-term interest rates of 21%. The dollar was on the brink of total collapse as gold rose to over 850 dollars per ounce (equivalent to over 2,200 dollars per ounce today).

The popular consensus of the citizenry at that time was that the United States had no future, and that our best days were behind us. When Reagan took office there was an indicator called the "misery index." The misery index was the sum of the unemployment rate and the inflation rate. At that time it stood at over 20. In 1984, just four years later, it had dropped to 11.5 which interestingly is higher than today.

Ronald Reagan, who few knew was a student of classical economics, initiated a radical reversal of the status quo policies of the day. When Mohamed Ali beat Joe Frazier and won over a million dollars, 91% of his prize was taken in taxes. Reagan reduced the top tax rate to 33% and reduced the lowest tax rate to 15%. He condensed 14 tax brackets into two.

The critics of this tax cut pointed to the resulting rise in deficits, which would triple the national debt during Reagan's term. There were fears that it would raise interest rates as government borrowing crowded out private capital. Instead interest rates fell. There were fears that inflation would rise and the dollar would fall due to deficit financing, but again, inflation fell while the dollar strengthened.

Naysayers feared the Government would not be able to pay its bills if taxes collected went down and debt owed went up. But tax receipts increased higher than ever before. Fears that we would fall into a deep depression not only didn't materialize, but the opposite happened. The US entered into a period of unparalleled prosperity. The stock market soared 300% during Reagan's term as President. Then went up an additional 350% after his Presidency.

Early on Reagan quipped, "My critics call this Reagonomics. I wonder what they will call it when it works?" What was the reason for this economic miracle? Reagan dramatically turned away from the socialist policies which dominated both academic thinking and public policy at that time. He reinstated capitalistic free market policies which were practiced during the industrial revolution of the 19th century.

The country remained on the same road that Reagan set us on until about 2007. Bush one, Bill Clinton, and Bush two did not veer much from Reagan' philosophy of low tax rates, sound monetary policy, deregulation, and free trade. This is why we had continued prosperity through the Republican and Democratic Presidents and Congresses until the financial crisis of 2007-2008. (For a complete discussion of what actually caused the crisis, see "The Elephant In The Room," in the Archive Articles.)

"My Take" is about bringing something new to the table. The above is now, pretty much common knowledge. But what you are about to read about my take on deficits and debt, is not. The biggest criticism of Reaganomics is the staggering deficits accumulated under his presidency. Deficit spending is what many critics mean when they talk about "failed policies of the past." But deficits, like all economics, are contextual.

There are three ways to pay for Government: Taxation, inflation, and borrowing. Of the three, only borrowing is voluntary. When government taxes, it is taking money by force. Another word for that is theft. When the Government inflates, it artificially increases the money supply thereby diluting individuals money which usually leads to higher prices. This is fraud, and also theft. But when the government borrows (runs a deficit) and accumulates debt, that is a voluntary act. The first two methods of financing government are coercive, and entail both forceful theft and fraud. The latter does not.

Faced with only bad choices, Reagan chose the least intrusive and most moral. How was his decision to borrow less intrusive and more moral? First, when the government sells bonds to raise money, it has to offer an interest rate a willing lender will find attractive enough to act on. Again, this transaction is completely voluntary. Second, while taxation and inflation hit everyone whether or not they can afford them, lending comes only from those who can afford it. And third, even though the government promises to repay its debts to all lenders, if it should ever default, it is the voluntary investors who would suffer the brunt of that default. By loaning to the government they also have the additional risk of default by inflation.

Ronald Reagan had to make many tough decisions about how to get the country out of its worst recession since the great depression. He did not choose to cut government spending in a time of recession and high unemployment. He did not choose to raise taxes in a time of excruciatingly high taxation. And he did not inflate in a time of impending monetary collapse. Instead he went to the investors of the nation and the world, and asked them for a loan. Reagan's decision to run deficits were not his greatest vice as claimed by critics, it was in fact, his greatest virtue.

Reagan acted as a president, not a dictator. Reagan did all he could to cut government spending as the economy improved. He proposed budget after budget that drastically cut government spending. Those budgets were voted dead on arrival by a spend thrift congress. The congress, who failed to act, bears more blame for the deficits of that period than President Reagan.

In my last article I stressed the hazards of government spending cloaked as "investment" in the economy. The one area I exempted was defense, a proper function of a limited government. Reagan decided he could not cut defense spending in the dangerous world we lived in at that time. In fact he decided to invest more money in defense on a bet that we could possibly bluff the Soviet Union out of the arms race which would eventually cut defense spending in later years. If there is any government investment that truly paid off it was that one. The Soviet Union capitulated, cut back it's nuclear arms, and eventually disintegrated altogether.

I suggest this was a much better investment than the money we have thrown at education only to see student scores drop. Or the money we put into Amtrak, the equivalent of the post office version of high speed rail. Or the money we have devoted to research and development, which after decades of much research has seen very little development. Real development has come only from the pharmaceutical and bio tech companies which come out with life enhancing medicines and devices on a yearly basis.

Today we are told that the consumer is partially responsible for the recession because of too much consumption. "Living high on the hog" is to blame for our economic problems. But Reagan rejected that notion, even back then, and after winning the 1980 election by a landslide said, "American's decided that the economic crisis didn't happen because they lived too well, it happened because government lived too well." An identification still all too true today.

Reagan decided that one of his first regulatory deeds was to allow individuals to work out of their homes. It had been illegal before that. He struck down that law and opened an era of entrepreneurship the likes of which have never been seen before. College kids like Bill Gates and Steve Jobs started businesses inside their garages. This one move toward deregulation launched the technological revolution we are still enjoying to this day.

When it came to labor relations Reagan, a past labor union leader himself, fired Patco labor union workers (air traffic controllers). This was a bold move which reduced labor union power through intimidation, and opened the way for a burst of productivity in the private sector.

Today, labor unions have been allowed to form within government, an act considered illegal by Reagan. This has led to the unfunded pension liabilities which are dragging states like New York and California downward. Reagan said, "We are a people that has a government--not the other way around." And he implored, "The government did not create the states, the states created the government." Such wisdom is rare in today's world.

Economics is contextual. Back in 1980, the greatest problems needing solved were inflation, excessive regulation, and taxation. Reagan, wisely knew his priorities and let deficits soar; temporarily. Eventually the deficit disappeared due to unprecedented growth, as Reaqan said it would.

Today the priority has changed. It is all about debt, debt , debt. Debt is our number one problem, and contextually is our number one priority. Debt has increased exponentially in the last few years. It is THE problem we must address. We can successfully address it, and I hope we will. I believe if Reagan were here today he would be leading the charge to cut spending and to balance the budget. Unlike 1980 when high taxes, runaway inflation, and regulation gone wild plagued America--today the plague is debt and irrational government spending.

Remember, in 1980, no one believed we could go from the mountain of debt we built up in 1984, to a balanced budget with surpluses just 16 years later. It was considered impossible, as it is today. I suggest we look at the world through Ronald Reagan's eyes. His philosophy was to let America be America. He knew that if you could get government off individual American's backs, they would show the world what is really possible, as they have again and again since the inception of this country.

In my opinion, the most important debts Ronald Reagan left us as President of the United States were NOT the government debts which eventually turned to budget surpluses. I believe he left an appreciative nation with debts of gratitude. Ronald Reagan led us out of a dire economic and monetary state of affairs towards his vision of a "bright shiny city on a hill." 
 
Paul Nathan