The Magic Economic Formula

It seems that we are in a period of economic decline. This might get a little tiresome eventually, and then maybe a few will start looking for solutions. If I could know the Magic Formula of economic success, what woud it be. Here it is: Low Taxes and Stable Money.

If you look at any of the great economic successes over the past two hundred years, you will usually find this combination. Likewise, most of the great failures have the converse: high (or rising) taxes, and unstable money.

Today, a rather energetic discussion of economic policy is taking place, but you will notice that almost nobody suggests anything that is in line with the Magic Formula. On the contrary, the trend is toward the opposite. Economic weakness begets heavy spending; heavy spending begets large deficits; large deficits beget a political trend toward higher taxes. They will eventually find out that higher taxes beget economic weakness.

President Obama has already outlined his preferences for a reversal of the Bush tax cuts, plus still higher taxes on upper-income earners, plus a removal of the upper-income cap on payroll taxes, plus additional increases in capital gains taxes. But this is just the beginning; there is serious talk of introducing a national VAT in the US.

What about the stable money part of the equation? The most stable money, historically, has always been produced by a gold standard. That is the gold standard’s purpose. However, beginning especially in the 1930s, a new ideology arose. We no longer wanted stable money. We wanted money we could manipulate, so we could fool people into doing things they would not otherwise do. Alas, this sort of thing has consequences, and they are usually not too pleasant. The US dollar has already fallen to 1/50th of its original value due to our belief in monetary manipulation. The next 50-fold decline might take place in a much shorter period.

Thus, we have higher taxes and, I expect, increasingly unstable money. On top of a dozen other things you could name. Do you see what I mean about an era of economic decline?

I know that many learned economists will say: “Yes, that is interesting, but we can’t afford a major tax cut at this time. Plus, we need all the help we can get from monetary policy.” This is what people always say in the early period of an era of economic decline.

The fact of the matter is that you can always reduce taxes. Some of the most brilliant tax cut strategies have come from governments in the direst situations imaginable.

Russia was a disaster zone when Vladmir Putin introduced a 13% flat income tax in 2000. Over the next seven years, the average worker’s salary (in US dollars) increased by an astonishing 30% per annum.

Germany was in even worse shape in 1949. In the years after the war, hyperinflation raged and millions died of starvation. Much the same was happening in Japan. Both enacted huge tax cuts in the early 1950s. Japan even went so far as to require a balanced budget by law. Both introduced gold-linked currencies at the same time.

This is the kind of thing that happens in the early stages of an era of economic success. The results were very much in line with Russia or China over the past few years. You’ll notice that Russia and China today have little interest in monetary manipulation, but are teaming up to establish an international currency regime that promises more stability than the mismanaged US dollar. Russian president Dmitry Medvedev even presented a 1/2 oz. gold bullion coin at the most recent G-8 meeting, as an example of the international currency of the future.

Why did Germany and Japan go this route? They did it because they finally got fed up. Once they got fed up enough, they started to look for answers. The answer was the Magic Formula, although they didn’t call it that in those days.

Politicians today, especially in the US, are nowhere near that point. They still think they can spend and tax and devalue their way… not to prosperity exactly… but to a continuation of the status quo. The status quo in which they are somewhere near the top.

Source: Gold: the Once and Future Money (2007) by Nathan Lewis

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