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Sunday, July 30, 2006

Losing Elections / Faux Conservatism

Originally posted: April 23, 2006 -- 7:13pm
Fool Boards link: http://boards.fool.com/Message.asp?mid=24009139

A recipe for combining optimism, ignorance and cynicism into a winning strategy for elections and a losing strategy for governing.


In another thread,


I made a comment that Democrats have failed miserably in three key areas with American voters:

1) explaining that the "starve the beast" strategy of Republicans doesn't work
2) explaining that cutting taxes CANNOT be the solution to every problem
3) explaining that voting people who claim to ABHOR government INTO government makes no sense

goofyinMD posed the following questions in response:

Why do you think it was so easy to make the majority of Americans think government was screwing them.

Or let me put it another way.

It was fairly easy for the Republicans to sell the idea that big government, fueled by high taxes was the problem. Why was it such an easy sell?

I've been mulling over this for quite a while, actually. Here's my best guess.


Republicans succeeded in selling a flawed ideology of government to American voters due to two key factors:

* monumentally poor communication about basic economics and policy by Democrats
* faux conservatism on the part of the American people.

I say "faux" because words like "misguided" or "deluded" or "tragically uninformed" would come across as too harsh.

In a nutshell, this "faux conservatism" resulted from a few key factors:

1) macroeconomic shocks between 1973 and 1981
2) ignorance of basic fiscal / economic theory
3) American optimism / wishful thinking

Macroeconomic Shocks from 1973 to 1981

Macroeconomic shocks that affected the US produced recessions and recoveries whose causes and fixes were not understood by the American public. My amateur economist summary of the basic chain of events is:

* spending on the Vietnam War institutionalized deficit spending and bad fiscal policy
* the Arab oil embargo in 73-74 spiked oil prices and started feeding inflation
* inflation expectations were baked into labor contracts in already inefficient industries
* bad fiscal / monetary policies in 76-80 timeframe fueled higher inflation

By 1980, the embarrassment from the Iranian hostage situation and the stalled economy led voters to try Reagan for a change. At this point, die-hard Republicans believe Reagan took the reigns and single handedly snapped the country back to the golden path via huge tax cuts and cuts of government programs and spending.

Well, at least half of that is true.

Reagan DID cut taxes. However, drastic increases in military spending (which in hindsight, we probably didn't need because Russia was already destined to rot from within) actually increased government spending and drastically increased yearly deficits. In the end, Reagan's policies TRIPLED our total national debt from $930 billion in 1980 to $3.233 TRILLION in 1990. (#1)

I believe the two most important factors that drove the eventual recovery from 1983 on were:

* monetary policy changes that spiked interest rates from 80 through 81 (#2)
* skyrocketing oil prices due to the Iran / Iraq war (#3)

The prime rate got as low as 11 % by July 25, 1980 but shot up to 21.5% by December 1980 and remained above 15% through 1981. At the same time, oil prices spiked due to the Iran / Iraq war. Unemployment ranged from 7.2 to 8.2 percent under Carter but went from 8.2 to a high of 11.4 percent in January 1983 under Reagan. By the time of Reagan's "morning in America" re-election campaign in November 1984, unemployment had only come down to 6.9 percent. (#4)

In short, macroeconomic factors having nothing to do with Reagan and the Republican Party induced one of the worst recessions the United States had ever experienced, which drastically cut inflation. (#5) The recovery was magnified by a dramatic, coincident drop in oil prices which had nothing to do with Republican policies, tax cuts or fiscal management. Instead, the drop was due to a breakdown of pricing collusion within the OPEC cartel as members desperate for revenue in the face of drastically reduced demand flooded the market with oil at prices below the official OPEC cartel "list price."

Ignorance of Basic Fiscal / Economic Theory

To me, a true lower-case-c conservative would never live beyond their means, would minimize personal debt, would habitually save for a rainy day, and would expect their government to do the same. That certainly doesn't describe the average American at this point. The average American has over $7500 in high-interest revolving credit card debt, is borrowing against the equity in their home to buy plasma TVs and giant SUVs, has maybe $15 to $20k in retirement savings, and has virtually no cash savings. I'm guessing the average American is no more than 2 or 3 months from losing their house if they lose their job.

If Americans cannot understand the long term impact of deficit spending in their own household, it's no surprise that they continue voting incumbent politicians back into office for more drunken sailor spending.

The average American also lacks an understanding of two of the most important concepts within economics

1) public and private goods and externalities
2) moral hazards

A famous essay entitled "The Tragedy of the Commons" (#6) illustrated the problem of private use of public goods using the metaphor of a common pasture shared by multiple herdsmen. Each herdsman can add another animal to his flock, have it graze on the shared pasture, net ALL of the proceeds of selling the animal, but pay only part of the cost to the pasture by overgrazing it by adding the extra animal. If only one herdsman makes that decision, he benefits. However, if ALL of them reach the same conclusion, ALL suffer because the pasture becomes overgrazed and cannot sustain any of the animals.

The overuse of the shared public resource is termed an "externality." When economic policies allow private individuals or businesses to enjoy 100% of the gains from using a resource for which they pay less than 100% of the cost, society as a whole can suffer. This is the root issue involved in policy debates about energy, pollution, natural resources on public lands, etc.

These concepts sail completely over the head of most Americans. It is easy to argue for reduced government regulation making an individual business more efficient when only considering the costs actually incurred by that business. However, without understanding the concept of "externalities" and understanding exactly how a company is producing savings, dangerous social consequences can often occur.

Economists define a moral hazard as a situation in which an individual is protected (or THINKS they are protected) from the full cost of a potential problem (a natural disaster, a car wreck, etc.) and consequently behaves in a way more likely to actually incur the problem. In economic terms, by reducing the marginal cost of the disaster to the individual, they do less to avoid it, thus INCREASING the actual cost to society.

The concept of a moral hazard is involved in a huge variety of public policy debates ranging from consumer product safety, FDA regulations, health insurance, flood insurance, social security, and bailouts of banks, Savings & Loans, and big businesses, etc. When government actually promises to be the safety cushion of last resort (or simply fails to clearly state it does NOT intend to fill that role), the existence of that safety net actually encourages many to take larger risks than they would without that backstop. When more and more risks are being taken at the same time expecting to draw on the same resources to bail them out when something bad happens, REALLY BAD THINGS HAPPEN.

American Optimism / Wishful Thinking

The American economy did pretty well from 1986 through about April 2000 when the NASDAQ and Dow peaked during the Internet bubble. We had a relatively minor recession from late 1988 through 1990 that probably cost GHWB a second term. However, the economy rebounded primarily due to a reduction in concern about Cold War expenses with the collapse of the Soviet Union and Berlin Wall and a divided Congress that kept spending in check. Things continued to improve during Clinton's first term due to more divided government deadlock and resulting spending restraint. By 1996, the economy had been rolling for five years and was then further stimulated by two factors for the next four years. The Telecommunications Act of 1996 created an artificially large demand for high-dollar optical and telecom gear for new CLECs. Technology spending then skyrocketed as businesses overestimated the benefits of Internet technology and pent money on Y2K software issues. The Fed then added fuel to the fire by easing interest rates in anticipation of a Y2K economic burb that never happened.

Americans saw a landscape where 25 year old engineers were making $80,000. Where people who knew NOTHING about investing were seeing their portfolios grow 10-20 percent annually. The vast majority naturally reached only one logical conclusion from surveying this scene:

I am a rugged, individualistic, self-sufficient financial genius. And I did it all myself.

Who cares about Social Security? I'm going to retire at age 40 on my dot com pre-IPO shares. Who cares about pension funding? I'm going to be independently wealthy. Who cares about employment stability? Every time I change jobs, the next dot.com is raising my salary by $15k. Who cares that I had to take out a zero-principle ARM on my $700,000 McMansion? Real estate prices are going up 10 percent annually as overpaid dot.com workers drive up sale prices so I'll make money on the deal.

As someone once famously said, things that CAN go wrong usually don't, then people draw the wrong conclusions. This mindset is a quintessential example of that phenomena.

Another witticism also comes to mind... "Things really ARE different this time, just not for the reasons you think." People thought the economy was doing well because Internet technology cured the business cycle and we all became highly productive geniuses. In fact, the economy was being over-stimulated by flawed telecom deregulation policies and easy monetary policy that was overcompensating for an upcoming Y2K disaster that didn't materialize.

Americans have historically been an optimistic lot and much of that optimism has been historically justified due to our unique combination of political climate, natural resources and splendid geographic isolation from the rest of the world. However, that optimism has delayed recognition of the impacts of a global market for labor and the potential downside of the tremendous concentration of economic power in fewer but ever larger multi-national corporations. China's President spent just about as much time talking with Bill Gates of Microsoft and John Chambers of Cisco as he did talking to Bush during his recent visit. What does that say about the balance of power between government and industry within the United States?

So What Is Finally Waking Americans Up to Reality?

I'd like to think Americans are waking up due to the costs we are incurring due to our misguided "war on terror" and the spectacular lack of tangible results. However, if most Americans grasped even 25% of the magnitude of the avoidable strategic mistakes the Bush Administration made, I would guess there would be a million people surrounding the White House daily demanding Bush's resignation. That clearly isn't happening so I'm guessing the awakening is due to traditional pocketbook factors.

In my day job, I am involved with a project that my firm has contracted out to a major consulting firm who has assembled a team of about 30 people for the project. Of that group of 30 people, I would estimate about 80 percent of them are foreign nationals here on guest worker visas. These are extremely bright people who almost to a person are as skilled as American citizens that could have done the work. The only difference? I don't know exactly what they are being paid by the consulting company but I am guessing it is at most only 60 percent of what we are effectively paying the consulting company on a per-hour basis.

American workers are seeing this happen ALL THE TIME and are starting to realize it isn't just $70,000 per year factory jobs at GM at risk, it's $70,000 to $100,000 jobs in programming, project management and all the other "new economy" jobs the Internet boom was supposed to produce.

American workers are watching healthcare costs skyrocket and healthcare coverage shrink every year to the point where many workers probably care more about health insurance coverage in retirement than an actual pension. By the time they retire, monthly health care premiums might be $1000 to $1500 (if they're not there already).

Americans are looking at natural disasters like Katrina and seeing how a big economic hit can literally stop a local or regional community in its tracks. At a time when they are most vulnerable, many Americans are also seeing big businesses use its power to weasel out of contributing its fair share. As a poster on the Fool noted last week, even Trent Lott, a poster child of the anti-trial-lawyer perspective, suddenly wants to sue State Farm Insurance after rumors came to light that State Farm destroyed evidence that would have confirmed policy-holders were owed settlements for damage done by winds, not by water. It's amazing how quickly you learn government DOES have a role in maintaining a stable, equitable society after losing your house and losing your job and losing every physical possession you have.



#1) Total US Debt From 1910 to 2004: http://www.answers.com/topic/u-s-public-debt
#2) Prime Interest Rate History: http://mortgage-x.com/general/indexes/prime.asp
#3) Oil prices History: http://www.wtrg.com/oil_graphs/oilprice1947.gif
#4) US Unemployment Statistics: http://www.dlt.state.ri.us/lmi/laus/us/usunadj.htm
#5) US Inflation Graph 1976 to 2006: http://www.clevelandfed.org/research/inflation/US-Inflation/
#6) Tragedy of the Commons: http://dieoff.org/page95.htm