The election is over and now the worrying starts. It appears, at least as I write this, that the Democrats will fall short of their 60 seat goal in the Senate. Nevertheless, they have picked up seats and with liberal Republicans like Susan Collins around, they will be able to move a significant portion of their agenda. That has me and a lot of other people worried:

It’s the day after a historic election and I can’t help but worry. I’m one of those people who are pessimistic about the near- and medium-term prospects for our financial markets and our economy.

I’m not pessimistic about our country or our capitalist system: They are not the problem. I am pessimistic about whether our next president and the savants in Congress can deal with the massive economic issues we face.

That’s Harvey Golub, former chairman and CEO of American Express, who has a very Austrian sounding editorial in the WSJ. Golub doesn’t think much of the economic acumen of politicians:

Members of Congress, regardless of party affiliation or yesterday’s results, will continue to meddle in matters beyond their knowledge. In doing so they will exacerbate our current economic downturn and delay the recovery of our financial markets.

In recent months, Congress has displayed a fundamental lack of understanding of how our economy and our financial markets actually work. Members believe they can say a bank is likely to become insolvent and that will not lead to a run on the bank, or say a major insurance company is in trouble and not have insurance stocks tank. They believe they can extend a $700 billion Troubled Asset Relief Program (TARP) beyond its charter and not have every institution under the sun try to get what they believe is cheap capital.

Most significantly, although Congress is a large cause of the collapse of the home-mortgage market (witness the folly of Fannie Mae and Freddie Mac), members believe the markets are too stupid to recognize Congress’s culpability and will maintain confidence in Congress’s ability to resolve the financial crisis.

As Golub points out, the basic problem with our economy is too much debt. This debt was encouraged by the Fed and abetted by Congress, but that is relatively unimportant right now. The only way to solve a problem of excess debt is to reduce the debt as a percentage of our assets. That’s why the politicians are working so hard to stop home prices from falling. The lower the value of the asset, the larger the debt burden. But that is not a solution; but merely a way to put off the day of reckoning. Propping up housing prices will just lengthen the time it takes for housing prices to fall to the market clearing level where the inventory can be reduced quickly. This is basic economics. The government can attempt to control either price or supply but not both. If prices are held up artificially, the supply of housing will also stay high.

If the goal is growth, it would seem obvious that the supply of homes needs to fall so builders can start building again and employing construction workers. The longer the politicians hold up the correction process, the longer the construction workers stay out of work.

There are any number of things that Congress can do to make the problem worse:

If Congress passes a stimulus package that simply gives people money — like this year’s $168 billion stimulus package, which was mostly rebates — they don’t get it. Rebates will not stimulate the economy and will not solve the underlying problem.

– If Congress tries to “help” the people who cannot afford the house they are in, be assured that we are wasting money and delaying the recovery. (Banks can decide better whether to foreclose or make a deal far better than any governmental entity.)

– If Congress forces the Treasury to provide cheap equity to companies which are solvent, or to automobile companies because of the debt owed unions in a politically important state, or if it continues with politically motivated spending, all of us will suffer a long and deep recession.

– If Congress raises marginal tax rates and erects trade barriers, and makes it easier for unions to organize without secret ballot through “card check” legislation, then the recession will be even longer and deeper.

Anyone who has read anything about the Great Depression knows that the items listed in that last bullet point are basically the same as the policies of Hoover and FDR. Those policies extended the depression by years. Here’s what bothers me (and obviously Havery Golub); those are all things that a Democratic Congress is attempting to accomplish. They are the anti trade party because they are funded by the unions. And they have enough stupid Republicans to pass some very damaging trade legislation. There was nearly enough bipartisan support to pass a bill last year raising tariffs on Chinese goods by roughly 25% unless they revalued their currency. In other words, they threatened tariffs unless the US was allowed to devalue the US dollar. That sounds eerily similar to the competitive devaluations of the 1930s. No country has ever devalued its way to propserity. If that worked Zimbabwe would be wealthy beyond imagination.

Like Golub, I’m very worried about what type of legislation we might see from the new administration. Investors will need to keep a very close eye on what emerges from Congress.

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