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Change on the margin is the key



Clifford Asness has a very nice op-ed in today's WSJ: "Uncertainty is not the Problem." I'm guilty of doing what he describes, which is arguing that the uncertainties created by massive quantitative easing and a huge expansion of government spending are acting as headwinds to economic growth. It's not the uncertainty surrounding bad policies (e.g., a huge increase in spending today means we could see a huge increase in future tax burdens) that is bad for the economy, it's the bad policies themselves. Unless policies change, we will see higher tax burdens and greater regulatory burdens, and that is bad; the fact that there is still some uncertainty about how bad it will be for the economy, or exactly how much tax burdens will rise, is not as important as the fact that the future looks less attractive for business.

... the stimulus was wasteful and politicized, and the American people, not being idiots, know they will have to pay for it eventually. People adjust their plans to account for the additional debt heaped on them, meaning lower investment and consumption.

He goes on to illustrate how things could improve dramatically even if the degree of improvement were still uncertain:

... consider good policies surrounded by uncertainty. Imagine we will move from here toward free-market health-care reforms appropriate for a free people. We will reduce government spending and our debt, letting people spend their own money as they see fit. We will lower taxes across the board for individuals and businesses, and we'll reduce and simplify deductions.
Imagine even more that we'll make grown-up decisions and reform entitlements to levels we might possibly afford. Now imagine that while we know the direction of each of these policy changes, alas, we are very uncertain about how far these wonderful ideas will go. Imagine this uncertainty is even higher than it is around today's bad policies. Would these changes, uncertainty and all, make things better or worse? Well, it seems pretty clear that should these changes occur in any nontrivial fashion, you would have to duck to get out of the way of the ensuing economic boom, regardless of the uncertainty.
Focusing on "uncertainty" takes our eyes off the ball. We should not seek clarity about the many new drags on our economy. We should seek to have the administration cease and desist, then reverse them.

This reinforces my belief that the plunge in equity prices in the early months of 2009 was largely driven by the horror show that was otherwise known as almost $1 trillion of fiscal "stimulus." Prices have rallied since then because a) the economy did not collapse into a black hole of depression and deflation as the market expected in late 2008, b) the market began to see that Obama's lurch to the left was meeting resistance, and c) more recently, the market has begun to believe that policies might at some point reverse, in a more growth-friendly direction. If the elections next year have the effect of reducing spending, reforming entitlements, flattening tax rates and broadening the tax base, then there is a tremendous amount of upside potential in the market. The only uncertainty is the degree to which things will improve. Already we see that the political debate has shifted meaningfully: nobody can argue successfully for more spending and new entitlement programs—the political debates now turn on whether and by how much we can cut spending and reform entitlement programs.

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