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Weekly Update from Donald Coxe

Real Media:
http://207.61.47.20:8080/ramgen/archivestream/dcoxe.rm

Macleans Magazine:

Government is good?
DONALD COXE

The post-Cold War global geopolitical structure has been transformed -- at least temporarily -- by terrorism. Russia, China, many of the former Soviet republics and Pakistan are giving at least rhetorical support to the U.S. war effort. Israel and India are sulking, and Canada is belatedly trying to seem relevant. The economic and financial world may have undergone an even more dramatic transformation.

The end of the Cold War produced a replay of the Roaring '20s: soaring optimism, soaring stock prices, falling inflation, falling interest rates, and a growing consensus that government -- particularly the military -- was too big and should get out of the way of the private sector. (In the '20s, the president said: "The chief business of America is business"; in the '90s, the president said: "The era of big government is over.")

The post-First World War era ended with a crash. The post-Cold War era ended with four crashes.

The U.S. economy was already in weakened condition and stock prices were already down substantially when the first plane hit. But the rapid earlier actions of the Fed -- with seven rate cuts -- and President Bush and Congress, with a super-fast tax cut package, had ensured that things would start getting better soon.

Bin Laden Air hit the economy and stock market hard. The collapse in the travel industry and the threatened bankruptcy of the airlines took the patient from the recovery ward and into intensive care. There were other consequences. Suddenly, the American heroes were in government, not the private sector. Whether it was the firefighters, the police, the rescue workers, Mayor Giuliani, President Bush, Colin Powell, the members of the now united House and Senate, or the U.S. military, it was government that was crucial and admired.

Bush and the Congress didn't just agree on emergency help at Ground Zero: they also agreed on getting the guilty and defeating "every terrorist group of global reach." The nation is overwhelmingly behind the war effort. A year ago, we learned the U.S. was spending three per cent of its GDP on defence -- equal to the level at the time of Pearl Harbor, and down from a Cold War-winning 6.3 per cent in the second Reagan term. As several conservative commentators noted, it was reasonable to predict another Pearl Harbor within a year.

The less the federal government spends, the higher stock prices go. (The reason is that as the government reduces its share of total spending, the slack is taken up by the private sector.) What is clear from all the emergency spending packages heading for congressional votes is that the crisis has emboldened every special interest, from peanuts to steel, to demand assistance. Government is getting bigger -- fast.

That sudden reversion to pork barrelism at a time of record monetary expansion worries the bond market. Long-term bond yields are not following the Fed as it drives down interest rates (the Fed has lowered its basic rates from 6.5 per cent to 2.5 per cent, with the last percentage point coming since Sept. 11). Result: one of the steepest yield curves in history. (The yield curve is an imaginary line drawn between treasury bills and reaching out to 30-year bonds, showing the return for each when the coupon rate is measured against the latest market price. When the curve is steeply upward, investors are saying they are worried about inflation.)

Another reason for government's return to centre stage is a growing realization that the private sector overplayed its hand. Those bureaucrats and politicians don't look bad these days compared with many of business's biggest names. During the 1990s, government stepped back and let business create the wealth and dynamism needed to make the economy hum. That love affair with laissez-faire may be ending. It wasn't government that drove the Nasdaq index to 5,000 in the biggest financial foolishness of all time. It wasn't government that grotesquely overinvested in telecommunications, creating a glut that could take years to clear and savaging hundreds of thousands of jobs.

Free marketers told us government was the problem, not the solution. They said market disciplines rewarded those who created wealth and punished those who failed. Those indeed are basic principles of capitalism. Trouble is, numerous CEOs grew obscenely rich from sports-star-style pay packets overlain with gigantic long-term stock options. When the bubble burst, small investors and lower-level employees lost their savings and jobs, but the big guys who had become media heroes remained rich and, in too many cases, still employed. Why, some stockholders wonder, did insiders insist they deserved those riches because of high profits and high stock prices, but now say circumstances beyond their control have led to collapses in both? Isn't that the way politicians have always talked?

The interlinked postwar eras of peace, falling inflation, falling interest rates, soaring stock prices and shrinking government may have ended on Sept. 11. Who knows what will succeed them?

Donald Coxe is chairman of Harris Investment Management in Chicago and Toronto-based Jones Heward Investments
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