Dueling Fools: 2008 Bear

Those who fail to learn the lessons of history are doomed to repeat them. As 2007 draws to a close, the parallels to the onset of the Great Depression are uncanny.

One event that led to the Depression was a stock market crash caused by excessive speculation enabled by too-easy leverage. Substitute "housing" for "stock market" and know that "subprime mortgages" are simply a form of "too-easy leverage," and you have the first sign that history could be repeating itself.

The question isn't whether we will have economic problems in 2008. Thanks to the housing slump and idiotic energy legislation that will keep forcing inflation down our throats by turning ever more food into fuel, that much is pretty certain. The real question is whether election year pandering by the current crop of politicians will give us 1970s-style stagflation or the next Depression.

The more things change ...
The economy is cyclical by nature. When politicians interfere to "help," they tend to make matters worse. Take the plans being discussed to bail out the housing market. Even ignoring the opportunity costs of such proposals, a housing slump brings with it many long-term benefits that won't happen if a successful bailout can be engineered.

After all, falling home prices mean both better housing affordability and lower property taxes. Lower taxes and cheaper housing free up more money to invest or spend on something else. That freed-up cash should provide the basis for the next expansion. Writing off bad investments by real estate companies such as Simon Property Group (NYSE: SPG  ) and Toll Brothers (NYSE: TOL  ) is really the first part of a cure.

Unfortunately, no politician wants to be seen as sitting on the sidelines, in spite of the very real long-term negative consequences of their "help." Ironically, assuming there's any success from a bailout, all it'll really do is postpone the day when the real recovery can begin. Strike 1 against 2008.

Speaking of bad policies
The horrendous energy bill that's little more than a handout to Archer Daniels Midland (NYSE: ADM  ) is bad enough on its own. Unfortunately, the government seems bent on boosting inflation in other ways as well. Protectionism run amok helped deepen the Great Depression, thanks to retaliatory tariffs after the U.S. started raising its own. These days, protectionism comes in the form of attempts to label China a currency manipulator and otherwise weaken the dollar.

The proclaimed goal of these protectionist policies is to help shore up sagging domestic manufacturers like Ford (NYSE: F  ) and General Motors (NYSE: GM  ) . Unfortunately, no amount of government intervention will fix problems caused by decades of internal mismanagement. What that intervention will do, however, is alienate trading partners such as China and OPEC, and lead to ever-higher prices on the stuff we either import or make domestically.

Consider for a moment the reason Congress keeps threatening a "windfall profits" tax on gas giants such as ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) in the first place. It's because gas prices are high. Further weaken the dollar (sorry, make that "encourage China to strengthen the yuan"), and those gas prices will simply get higher in dollar terms. Strike 2 against 2008.

When the Fed abandons its duties
In addition to the destructive actions coming out of Congress, the Federal Reserve seems determined to do its part to fan the flames of economic disaster. In spite of spiking the prices of food, metals, and energy, the Fed seems strangely focused on doing nothing more than trying to reinflate the housing bubble by lowering interest rates.

The rule in a crisis for a lender at last resort, such as the Fed, is to "lend freely, quickly, usually at punitive rates, and usually against good collateral." By lowering rates, the Fed is instead encouraging cheap loans against overvalued houses -- exactly the opposite of what it should be doing. This can't possibly end well.

That's strike 3 -- and the U.S. economy is out for 2008.

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