Speech before the National Regulatory Services’ Compliance Conference, La Jolla, CA, on September 11, 2002
A year ago this morning, Osama bin Laden and the terrorist network al Qaeda attacked the United States. They hate us and have given many reasons why. However, I believe the unstated reason is that they envy our economic power and strength — in comparison to their relative poverty and backwardness. In effect, they were attacking the heart of our capitalistic system.
One of my colleagues at the Hoover Institution at Stanford University, Alex Inkeles, in his definitive study, On Becoming Modern, points out that some societies do not develop economically because they are shackled by their traditions. This is true of many Muslim countries where success is frequently attributed to the “Will of Allah” rather than to personal efforts. In contrast, one country, the U.S., accounts for twenty percent of the world’s productive capacity with only five percent of the world’s population.
In March 2000, the U.S. stock market reached an incredible value of $16 trillion dollars. The Dow Jones Industrial Average touched 11,700; the NASDAQ over-the-counter market vaulted to 5,050, and the S&P 500 Index reached 1,530. Never before had such massive wealth been created in only one short decade. Now, of course, we know that we were in a very large “bubble.” Today, the value of all publicly traded stocks is “only” $10 trillion. The Dow is below 8,603, the NASDAQ has shrunk to 1,324, and the S&P 500 Index is at 909.
Today, we are the only superpower in the world. We are the capitalist model to the world and also the most democratic. How did that come about and how can we maintain that position of superiority? First, let’s review a little history.
At the close of World War II, the U.S. possessed two-thirds of the world’s productive capacity and also two-thirds of the world’s equity. Fifty-seven years ago, the United States found itself the strongest country in the world — a position previously held by Great Britain. In contrast, the Depression years of the 1930s were a disaster for our country. The economy was in shambles and unemployment hovered around 25 percent. In other words, one in four workers had no job. Then, preparations for war quickly eliminated that unemployment.
Although 300,000 Americans were killed out of an armed force of 16 million, our WWII losses were small compared with other nations. Whereas Europe, Japan and China suffered great physical and human losses, the US industrial might grew steadily during the war. We produced vast amounts of war materiel, and that was a major factor in our eventual victory. Except for Pearl Harbor and two tiny islands in the Aleutian chain in Alaska, we suffered almost no property damage.
During the period 1939 through 1945, the per capita income of Americans doubled. Consumer goods were not being produced and with nothing to spend it on, savings built up. Personal savings rose tenfold during that period and served as the currency used by the public after the war to meet the pent-up demand.
World War II transformed the lives of all Americans. Prior to 1940, most Americans had never been out of their home state. Between 1941 and 1945, some 12 million young Americans went overseas and were exposed to many different cultures. As an 18 and 19 year old, I served in the Philippines and in Japan. Prior to 1940, most adult women were homemakers and did not work outside of the home, except in a few occupations such as teachers, nurses and secretaries. During the war, women entered the workforce in droves to replace the men in uniform
After the war, millions of GIs earned a college education and the federally financed G. I. Bill of Rights paid for much of it. As a result, tremendous intellectual value was added to our country. Although I had started college on my own, the GI bill permitted me to earn a Master’s Degree, in addition to an undergraduate degree.
The US did not have much time after World War II to enjoy a tranquil peaceful life. Immediately after the end of WWII, the cold war began as the USSR pushed to gain territory for their communist ideology. Russia took over all of Eastern Europe and kept the eastern part of divided Germany. Our response was the Marshall Plan to help rebuild the European economy as quickly as possible. For the first time, the U.S. joined a foreign alliance with the creation of NATO, the North Atlantic Treaty Organization. Other major national security policies and programs were devised by Presidents Truman and Eisenhower to contain the spread of communism.
Because both the USSR and the U.S. had nuclear weapons, a standoff condition of Mutually Assured Destruction existed for many decades.
From 1945 to 1982, the U.S. stock market was stuck in a narrow range between 750 and 1,000 in the Dow Jones Industrial Average. There were alternating periods of excessive market advance and prolonged bear markets. In the early 1970s we had a mini-technological, growth bubble. Very high prices were bestowed on stocks of companies that were growing rapidly, and the top fifty growth stocks were given the label of “the nifty fifty.” You are too young to remember (don’t you like to hear that phrase?), but one darling stock at that time was the techno-marvel of the Polaroid Corporation, the maker of cameras that produced instant pictures.
After that bubble was deflated, there came a terrible period of the two-year bear stock market of 1973 and 1974. A weak economy during that period was aggravated by an Arab oil embargo of the U.S. The second half of the 70s was even worst as we suffered both a stagnant economy and high inflation. We had to invent a new word, “stagflation.” to describe our sorry condition.
Similar to today, at the end of the 70s we experienced a ‘crisis of confidence,’ as President Jimmy Carter called it. We had gasoline shortages, a stagnant economy with inflation, and our embassy personnel in Teheran, Iran, were held captive. Ronald Reagan was elected president in 1980. He promised to build up our defenses, cut taxes and balance the budget. After a dip in the economy in 1981, the current bull stock market took off on August 11, 1982 and soon the Dow Jones Average decisively crossed over the 1,000 mark for the first time.
However, the Japanese economy owned the decade of the 1980s. They were exporting cars and other high technology goods all over the world, and the quality of their exports was excellent. Silicon Valley worried that Japan would eat their lunch. The Japanese stock market and real estate prices rose steadily throughout the decade of the 80s. In 1989, the Nikkei average soared to almost 40,000 and real estate in Tokyo was so valuable that is was being priced by the inch. Now, their economy, stock market, and real estate have been in a 12-year slump and the Nikkei average is 9,350. Their stock market has lost 75 percent of its value.
Meanwhile, Communism had spread to Angola in Africa, and Nicaragua in South America, in addition to Cuba. In the early fifties, the war between communist North and South Korea had concluded in a stalemate. In the seventies, communist North Vietnam took over South Vietnam. However, the spread of communism was checked when the USSR tried to subdue Afghanistan, and then they experienced their “Vietnam.” And whereas the U.S. was spending only a modest amount of its budget on defense; the USSR was pouring half of its wealth into the military. As a result, their people lived a very poor existence, almost like a third-world country. During the 1980s they were having trouble keeping up with advances in U.S. military might and they especially worried about our proposed “Star wars” missile defense system.
In the mid-1980s, Soviet premier Gorbechev proposed a reform of communism through “glosnost” and “perestroika.” In glosnost, he wanted officials to tell the truth about the poor conditions in order that proper solutions could be proposed. In perestroika, he advocated that decision-making and programs be decentralized from Moscow into the local areas. However, instead of improving communism, his proposals resulted in a popular groundswell for more drastic change.
In the fall of 1989, the subjugated people living under communism lost their patience. They knew there was a better way. With their hands and whatever small tools they could find, Berliners tore down the Berlin Wall separating free West Berlin from communist East Berlin. Previously, on a visit to West Berlin, Reagan in a speech demanded that Gorbachev “tear down that wall.” Instead, the people did it. Shortly thereafter, communist-weary people in one country after another in Eastern Europe overthrew their communist dictators. In 1990, the USSR was dissolved and Boris Yeltsin succeeded Gorbachev.
The U.S. and the West had won the cold war. We proved to the world that free markets and capitalism and democracy are superior to the centralized communist economic system and dictatorship.
This ushered in a decade of worldwide prosperity such as the world has never seen before. In the United States, the stock market as measured by the Dow Jones Industrial Average vaulted from less than 3,000 in 1990 to 11,000 by the end of the decade. President Bill Clinton wisely followed the advice of Secretary of the Treasury Robert Rubin and adopted policies to benefit the economy (except for his tax increase of 1993 which resulted in the landslide Republican victory in 1994 led by Newt Gingrich and winning a majority of both houses of Congress).
Meanwhile, the decade of the 1990s saw the rapid growth of the Chinese economy. That country’s communist leaders allowed small family enterprises to be privately owned and gradually they allowed larger private companies to be formed. When China took over control of Hong Kong from the British, they permitted Hong Kong to continue its excellent free-market and low-tax policies. In fact, they allowed similar policies in Shanghai and other areas of China. This resulted in an annual economic growth rate of eight percent for several years.
In the small developing countries, their economies boomed in the 1990s, as they gave up central government controls in favor of free markets and free trade. The countries in Southeast Asia and on the Pacific Rim boomed so much they became known as the Asian Tigers. The little country of Chile in the most southern portion of South America prospered greatly under the policies of “the Chicago boys,” a group of economists who were trained in free markets under Professor Milton Friedman at the University of Chicago. Chile is the model of the world on how to successfully privatize a social security program.
In Europe, a dozen countries formed the European Union to more effectively cooperate economically. Recently, eleven of those countries gave up their local currency in favor of a unified Euro currency. While that currency had a shaky start, dropping from a starting level of 117 Euros to the dollar, then down to 83, and now it stands at par to the dollar. The dollar now has more competition. This change will be very good for Europe. Many financial analysts expect that the European economy and stock market will outperform the U.S. over the next decade.
The number of stock markets in the world rose from only four in the mid-nineteenth century to 50 today. Those statistics better than anything else illustrate the dramatic development of free markets and capitalism. Even the former communist states of Russia and China have stock exchanges! From the cold war, we learned that the economic system of communism was easy to explain, but it didn’t work; while the capitalist model works, but is difficult to explain!
While the West was enjoying its victory over communism and the world markets were booming, not everyone was happy. There were several acts of terrorism during the past decade that would be a portent to what happened on 9-11. Harvard professor Samuel Huntington in his study, The Clash of Civilizations, said, “The most dangerous dimension of emerging global politics would be conflict between groups from differing civilizations.” Islam is exploding demographically with destabilizing consequences, he warned. Believers of Islam (Muslims) throughout the world already number over one billion adherents. But Muslims are not our enemies – our struggle is against the extreme strains of Islamic fundamentalism that do not tolerate non-believers of Islam (or infidels).
How can we maintain our position of superiority? First we must always remember how we got here: maximum freedom for the individual in a low-tax environment. Also, there are several specific actions that I believe we can take to maintain and improve our capital markets:
Eliminate double taxation of dividends. Finance professor Jeremy Siegel calls our tax code an “un-indicted co-conspirator in the Enron case.” He correctly points out that dividends used to make up three-quarters of the total return on common stocks; now they represent only ten percent of the gain. We should do away with the double taxation of dividends. This would allow corporations to increase the dividend yields and take the pressure off of the present tax incentives that favor common stock price appreciation (and that exacerbated the recent stock market bubble).
Reduce corporate tax rates. Many U.S. corporations are suffering from a high level of taxation. Congressmen should face up to the fact that corporations do not really pay taxes. Corporations are in business to make a profit for their owners, not to pay taxes. Any tax levied on a corporation is passed on in varying degrees to three other parties: the consumer in the form of higher prices, the worker in lower wages, and the stockholder in lower dividends and capital gains. The fact that some corporations are trying to move their domicile to tax havens outside the U.S., such as Bermuda, should be an alert to federal, state and local governments that their tax rates are excessive.
Dividend and interest tax credit. Tax laws should be revised to give taxpayers a generous credit for dividend and interest income. This will reduce the pressure to ramp up the price of common stock because corporate directors and officers and stockholders smartly prefer the low capital gains tax rate instead of the high ordinary tax rate on dividends and interest income. This would also benefit lower-income persons who do not have sufficient capital to be in the stock market to reap capital gains that are subject to more favorable tax rates. This would improve the national savings rate that is now zero.
Increase tax credit for capital losses. For income tax purposes, Congress should allow a higher amount of capital losses to be deducted against other income. The present limit of $3,000 annually should be raised significantly, say to $20,000. Many investors have excess carryover of capital losses. This would reduce taxes and put more money in the hands of the consumer, and that would stimulate economic recovery.
Privatize Social Security. We should gradually shift over from the present unfunded social security retirement program to one where individuals have their own accounts and be allowed to choose their own investments. Chile has successfully made the transition from public to private retirement plans and many other countries are following suit.
Improve corporate ethics. Confidence in corporate America has been shaken by the collapse of several very large corporations – WorldCom, Enron, and Adelphia. The public will excuse poor business decisions such as the use of excessive borrowings. What they cannot tolerate is accounting fraud, executive greed and impotent corporate boards of directors. Our graduate schools of business need to do a better job of teaching ethics. Laws and regulations are fine, but they are no substitute for the internal compasses possessed by each individual as to what is right and what is wrong. The changes recommended above in the tax laws will reduce pressure on corporate directors and executives to push stock appreciation.
It’s true that everything changed on 9-11. However, let’s not change those things that made us successful in the first place: maximum freedom for the individual, capital markets as free from government control as possible, and low tax rates. Our best reaction to the terrorism of Osama bin Laden and al Qaeda is to improve even further the capitalist system they tried to destroy. Then, we can continue to be the Capitalist Model to the World!
Photo by Markus Spiske on Unsplash