Trading is not a game of exacts. Perfectionists need not apply. Markets are made up of many irration...
Steve Forbes: Markets and Politics
02/28/2003 12:00 am EST
Paul Kangas, in introducing Steve Forbes , said "Steve is the only writer to have won the highly prestigious Crystal Owl award four times, which is given to the financial journalist whose economic forecasts proved most accurate. He is the author ofNew Birth of Freedom, a new book of bold ideas for the new millennium." At the Opening Ceremonies of The Money Show, Steve Forbes, president, CEO and editor-in-chief ofForbes magazine, shared some fascinating and controversial insights into the financial markets, politics, taxes, and the state of the world.
"The timing of this show is absolutely extraordinary. In terms of what's going to happen...our economy, the stock market, the bond market...so much depends on decisions that are going to be made in the next few weeks. Obviously, Iraq is weighing on consumers, on businesses, and on the financial markets. When it looks like the crisis might be resolved, boom, the market goes up. When it looks like it might not be, it takes another hit. You see it in consumer confidence. You also see it in advertising. Advertisers are reluctant to spend until they get a better feel of what's going to be out there down the road. This uncertainty is weighing on the markets.
"Iraq is going to have enormous ramifications on what kind of environment we are going to be working in and investing in during the coming months and years. When the conflict is resolved, which it will be in coming weeks, you're going to see the stock market jump 30% to 50% in a matter of a few weeks. The reason is that the fundamentals are there for that kind of a rally. Productivity continues to do very well, despite some ups and downs. You see it in operating profits. Companies have cut back and have gotten their operations leaner and meaner. They are in much better shape than they were two or three years ago. Manufacturing is also starting to show some signs of life. So is capital spending. The fundamentals are there for a pop up in the market.
"If there is a war and it looks like there will be, there are issues we will have to face. The uncertainty is not about the ultimate outcome. If we decide to go in, we will win. But there remain four basic questions. One is what will terrorists do here? Will there be, for example, another anthrax attack? Second, will Saddam's officers in Iraq use biological agents against our troops? We just don't know. Third, will Saddam succeed in expanding the war? As soon as he feels we are going to move, he could launch missiles against Israel, Kuwait, and perhaps even Turkey and Saudi Arabia. I don't think he'll succeed in expanding the war, but he will try. I just don't think he will leave this world quietly. Finally, what will happen with the oil wells in Iraq? We all know that Iraq is the second largest producer of oil in the world. Saddam tried to destroy Kuwaiti wells in 1991. Will he be able to do that with the Iraqi oil fields this time? This uncertainty is what's weighing on us now.
"If as we expect the result of a war is more good than bad and things go relatively well, what then for the American economy? This gets to the importance of economic policy. The American economy is poised for real substantial growth in the future. We hear about bubbles, we hear about telecom disasters, and we all experienced the pain of the tech bubble. But the fact of the matter is that technology continues to move forward. Remember, we had great busts in railroads. We've had 400 different automakers in the US and only two or three are left today. You go through these things. In the 1980s, personal computers burst on the scene, and we all knew this was a big breakthrough. Remember Commodore, Atari, Franklin, Osborne? However, the technology still moved forward, and our homes and offices have not been the same since.
"There are several areas where policies are going to make a huge difference, and you as investors have got to be on top of it. One is an obvious one - taxes. One thing our political culture has failed to learn is that taxes are not just a means of raising revenues for governments. Taxes are a price and a burden. The tax you pay on income is the price you pay for working. The tax you pay on profits or capital gains is the price you pay for being successful - for taking risks that work out. The idea is a very simple one. When you lower the price and burden of good things like productive work, risk taking, and success, you get more taxes paid. Increase the burden, and you get less when the tax collector comes around. It's a very simple proposition. Yet, we have a tax system, where if your income goes up 10%, you're taxes go up 18%. The alternative minimum tax is nothing more than a punishment for being successful.
"The tax cut of 2001 was a disappointment. For all the ballyhoo of how big it was, it was puny. It was sold to us as a bottle of bourbon, but all we got was a weak cup of tea. It's phased in over several years and the cuts themselves were pretty small. They make it sound like a big deal, saying it will cost $2 trillion over ten years. Well I've got news for you. Any number over ten years sounds big. Just add up all the weight you've lost in diets over the past ten years! It's meaningless. However, what we do see, is that this administration is doing a very small dance towards overhauling the tax code. We could one day see a flat tax, which would increase the burden on consumption and reduce the burden on investment. It looks like the death tax may eventually meet its just desserts. The Russians put in a flat tax two years ago. I proposed a 17% rate. The Russians went even lower and put in a 13% rate. I never thought the day would come when a former Communist and ex-KGB agent like Vladamir Putin would get to my right on tax issues! But they did it. It's been an unmitigated success.
"The President has proposed ending double taxation of dividends. They don't do it from the corporate side they do it from the investor side, which is very, very smart. Just the other day, while everyone was focused on Iraq, they proposed the simplification of savings vehicles. The one that blew my mind was the so-called lifetime savings account. You can put in $7,500, and you can still withdraw the money at any time for any purpose. Dividends, interest, and capital gains would be tax-free. This is a small beginning, but you can see a pattern emerging. Here, we are seeing increasing depreciation for small business owners. Getting rid of depreciation schedules is a small step in the right direction. Today, if you have a tax loss, you have to carry it forward. But you should be making decisions for the right reasons, not for tax reasons. Look at what they are proposing on dividends. Again, it's not just getting rid of one layer of taxation. It creates more capital and gives incentives to invest, because you get to earn more on investments. It's also good for corporate governance. As you know, a lot of companies keep the profits rather than share them with stockholders. Now, they won't have the same excuse. If they want to keep the money they will have to convince you, the shareholder, that they can get a better return than you can. It's also good for corporate investing. It's all a move in the right direction. If the Iraq situation goes well, and the President gets re-elected, they may push for a tax overhaul after 2005. It's not just tax simplification. I think it is part of something bigger.
"As for Mr. Greenspan, I think he'll be looking for a job in 2004. I don't know who will replace him, but I hope it is someone who understands monetary policy. But Greenspan certainly doesn't get it on taxation. Again, it's not the size of the tax cut. The question is does the tax cut give people more incentive to create more capital, to take more risks, and to go out and figure out how to use your labor more productively. Economists call it the marginal tax rate. What is the tax you pay on each extra dollar you earn. Not the average rate. What's important to know is that if you earn extra dollars, will you get snared by the AMT? Will you move up to a higher tax bracket? Or is it worthwhile to take the extra risk AND move ahead? So if you get to keep more if you put your money at risk, lo and behold, things happen from places that you hadn't even expected. And when you look at what state and local tax authorities are trying to do, you realize that Washington has to do something on the tax front.
"This gets us to the Federal Reserve. I don't know what it is about central bankers. They get upset when people like you are happy. When the economy starts to do well, they worry. Will it be excessive? They always feel that if the economy gets a head of steam, they have to do something about it. Look at Greenspan; he always looks like he just came from a funeral. The danger you have to watch out for with the Fed is that inadvertently they tighten too soon. They tightened in the 90s, and then in 2001 they started to lower interest rates. They didn't do that very well. They lowered the rates, but they didn't make the money available. You not only have to cut the price, you have to make it available. It's like going to a gas pump and finding that gas is just 50 cents a gallon. But then you're told you can't buy any. For many businesses there has been a credit crunch in the last year and a half. Credit standards have been tightened. It's put a real squeeze on companies. But there are signs that liquidity is starting to ease up. But it's not enough to lower prices, they have to make that liquidity available.
"How do you know whether the Fed is doing its job right? Well, here's a dirty little secret. They don't know what they are doing, day to day. That's why Greenspan talks in Delphic terms. It's not that he doesn't want to show his hand, he doesn't know what hand he should be playing. It's true. While they talk about M-this, and M-that and about things that sound very complicated, the bottom line is they don't have the equivalent of a fuel gauge in a car. They don' t have a speedometer. They don't have anything. They have a lot of numbers, but they are flying blind. Greenspan has flown better than most, but they don't really know what gauge they should be following in terms of whether they buy bonds or sell bonds, create credit or extinguish credit - they really don't know.
"The way you can gauge as an investor or business person if the Fed is doing it right or wrong, is to look at something the economists will pooh-pooh. Look at the price of gold. Look at commodity prices. If they are inflating, creating too much money, they pop up. If they are not creating enough money or liquidity top meets legitimate demands, the price of gold and commodities goes down. Usually commodities are all over the lot, with some up and some down. When they tend to go in one direction, pick up your ears - something is happening. So a crude measure - but still better than anything they have in Washington - is to look at the price of gold. If it's around $350 an ounce, they have it right. If it goes above $400, watch out - they are inflating. If gold goes below $300, they are deflating. So if it stays around.$350-ish, you can heave a sigh of relief. Right now gold is going all over the place, because of uncertainties about the war. But after Iraq, watch that gold price very carefully. By just knowing that, you can personally be a better central banker than anyone in Washington, Europe, or Japan.
"So those are the critical areas to watch out for. Watch out on the tax front and watch out on the Federal Reserve front. In addition, watch the broad area of regulation and law, and that includes our legal system. Right now the great danger in the aftermath of what happened with Enron and those scandals, is this: it's not that we don't have enough regulations and laws (yet the SEC has come up with 3,000 new pages of regulations). This is not the way to go. To determine the kind of investment climate we have, see if our authorities - especially the courts and the regulators - are confusing genuine fraud and wrong-doing with risk taking that doesn't work out. Don't punish honest risk taking. Don't punish honest business mistakes. The whole system we thrive in is based on people taking risks and doing things that have no guaranteed return. As you know, most new businesses don't succeed. Making mistakes should not be a crime. So watch out that we don't confuse genuine wrong-doing with risk taking that doesn't work out. But today, when a company makes a dumb decision and the stock craters, they're going to end up in court. So watch that very carefully.
"In terms of regulation, watch the Federal Communications Commission. We all know what happened to telecom, with $1 trillion gone. But the FCC has made it worse. They made it worse after 1996, and helped create the bubble. The Internet has obliterated the traditional differences between long distance and local telephony. It will do the same thing with cable and television. There is a tech revolution going on. But in Washington, all the lobbyists are trying to behave as if the old world still exists. So they battle over who can go into what market. It's all rubbish. The technology is there, but we're still debating over Model-Ts. It's like having superhighways, but no access ramps. The technology is there from satellites, from cable, and regulators are standing in the way. What they should do is pick a certain date in the future, such as 18 months, and say, at that point, anyone can do anything. Let it be wide open. Let the market decide the winners and losers, not the lobbyists.
"Finally, we all know that we live in an international world. With our PCs at our fingertips, we can access Bangladesh, Bangkok, Canada, New York, Brazil, anywhere in the world. Yet we have an agency out there that is harming countries that are developing. It's called the International Monetary Fund. Whenever it looks like a country is having problems, they throw it to the IMF. The IMF is supposed to be the doctor for countries with an illness. But this doctor is guilty of malpractice. This doctor kills its patients, yet we keep throwing taxpayer money at this agency to help them continue to perpetuate its gross errors. They nearly did in Mexico in the 1990s; Russia, the Pacific Rim, Argentina, Turkey, Brazil. Yes, these countries made their share of mistakes. But the fact of the matter is that the doctors at the IMF made the patient's illness worse. When a country goes to the IMF, they send a team to the country. The team is wasting your money with their airfare, because they only recommend two things. One is raise your taxes, which is a pretty dumb thing to do when an economy is in trouble. It does not work. Then they tell the country to devalue their money, because of some theory about trade advantages. That may work in a classroom, but in the real world, guess what happens when you have a devaluation? The country that does it gets inflation, suffers flight of capital as no one wants to hold their currency, costs go up, and capital is destroyed. It's happened time and time again, yet the IMF continues to give the same advice. Then they wonder why the country gets sicker. Turkey went through it. This is a critical country - a secular Moslem nation. We want that country to succeed. The IMF should have pro-growth economic policies, not this mindless austerity. So what do you do with an agency like the IMF? I'm not naive enough to think we can get rid of it, but there is a neat reform we can do. If you work for the IMF, you're paid in US dollars. Even if you're not an American, you're paid in US dollars. And, you don't pay income tax. It's tax free. Pretty neat. I would suggest that from now on, instead of paying IMF employees in US dollars, they should be paid in the currencies of the countries they advise. And then they should pay the tax rates of the countries they advise. Don't you think that would sort of shift their outlook a little bit?
"For now, we're all riveted on Iraq, and rightly so. Big things are going to emerge from it. We also have to keep our eye on taxes, the Federal Reserve, what the courts and regulators are doing, and what the IMF is doing. I am an optimist. One of the nice things about a democracy is that even when we make crazy mistakes, we usually find a way to correct them, or at least mitigate them. Read the literature of the 70s; the world was coming to an end. Read the literature of the late 80s; America was losing out to Germany and Japan. Today neither is an economic powerhouse. When you look around the world, it looks like everyone is against us. You look at the demonstrators - all against us. Germany and France - against us. But remember, in Europe, the leaders of the rest of the governments have lined up behind us. In NATO, they voted 16 to three for us. All of the countries in Central and Eastern Europe are backing us. Meanwhile, France's Chirac - who considers himself a great lover - suddenly finds out that politically, diplomatically, and militarily, he's a eunuch. He is the old Europe. So don't get side-tracked by all the noise. If we show firm leadership, there will be plenty of countries with us in this coalition.
"We are already seeing modernization and liberalization in the Middle East. At a breakfast recently in Switzerland I heard the King of Jordan say that we're past the point of no return with Iraq. We see changes in places like Qatar and Bahrain, and Kuwait. They know they are at a dead end. After this war, you are going to see an intense push for a sensible peace process for Israel and the Palestinians. You will get the beginnings of a cold peace. They may not start hugging each other, but it is going to start to move in a more constructive direction. These people know there is a whole world out there, and that they are not part of it. So, there will be difficult times ahead. But if we just do a few things right, we have a fantastic future ahead of us."
The key risk-on and off drivers today are the same – U.S. politics, global growth, other centr...
Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...