Mushrooming Crisis......Steve Forbes

Fact and Comment
Steve Forbes, 01.09.06, 12:00 AM ET


Mushrooming Crisis
Iran's soon-to-be successful push for atomic weapons, not the Iraq war, will be the global hot potato of 2006. All diplomatic efforts to dissuade Tehran from going nuclear have predictably failed. Russia is not going to pull this radioactive chestnut out of the fire, either, even though members of the Bush Administration still pretend it will.

The prospect of Iran's having a nuclear capability is especially frightening because its new president, Mahmoud Ahmadinejad, is lethally delusional. He is obsessed with the Mahdi (who is to return just before Judgment Day) and believes he must prepare the way for his reappearance. Ahmadinejad has repeatedly declared that the Holocaust never took place and that Europe and the U.S. should provide some of their own land for a Jewish state. Israel itself should be wiped off the map.

Last month Iran cut a deal with Russia to buy an advanced weapons system that can destroy incoming missiles and laser-guided bombs. Russia also helped Iran launch a satellite that could give early warning of an air attack against Iranian nuclear facilities.

For Iran's black-robed fascists to develop nuclear weapons would be an immense setback in the war against Islamic fanaticism. It would embolden terrorists. Tehran would see itself in a position to encourage the overthrow of the Saudi monarchy--or, at the least, bend it to its will. Is military action the only alternative? Yes, unless somehow internal Iranian pressures (the mullahs are despised by most Iranians), as well as international pressures, force either a fundamental change in this fascist theocracy or its actual overthrow. Iraq's impressive progress since mid-2004 in building an economy in which new businesses are proliferating, property prices are rapidly rising, new schools and hospitals are opening, and a new democratic political order is under way can only undermine the mullahs, who preside over a sick economy kept alive solely by the oil windfall. But time is running short.

Could the Bush Administration summon the internal fortitude to undertake the necessary air strikes and possible ground action to set back Iran's nuclear ambitions for five to ten years? Alternatively, could one imagine the White House giving Israel the green light to launch air strikes?

Alas, the White House has done next to nothing to prepare and persuade the U.S. public of the possible need for stern measures here. Thankfully President Ahmadinejad's consistent public statements on the "myth" of the Holocaust will make clear to not only us but also the European masses and elites that this regime poses an increasingly mortal threat to our safety, that European-style diplomacy (a mechanism for doing nothing) is no longer viable.


Inflated Performance
Inflation is going to make the new year look better than it really will be. Excess money initially induces extra spending and more investment. For much of the year growth will exceed 4%, but by the fourth quarter it will start slowing. The hangover--i.e., much slower growth, if not a stall--will come in 2007-08. The Federal Reserve will continue raising short-term interest rates, but unless it stops printing an excessive amount of money, it will give us a replay, although a milder version, of the dreadful stagnation experiences of the late 1970s and early 1980s. The nominal cost of money went up and up, and so did prices.

Alan Greenspan will have left town by the time his inflationary blunders become all too evident. Greenspan & Co. started to turn out excess money more than a year ago. That's why prices went crazy at the gas pump last year. The higher cost of oil is not the fault of China, India, hurricanes or greedy oil companies. Inflation is the villain, just as rapidly rising energy prices were the result of the Fed's excesses in the 1970s. Prices have soared for a variety of other commodities, such as copper, soybeans and cattle.

The Fed's blunder is a shame. The economy's fundamentals are astonishingly strong--productivity gains of historic proportions, low inventories, growing capital spending and very sound consumer balance sheets (media myths to the contrary).

Ben Bernanke, Greenspan's about-to-be successor, disdains gold as both an indicator and a guide to monetary policy; he won't be prepared for what's going to hit him. He'll look at the Fed's multitudinous measures of money and conclude they haven't grown enough to cause inflation. No one has taught him that he can't just look at supply--he also has to look at demand. The world is flush with liquidity. U.S. corporations have nearly $2 trillion in cash, a record high in absolute terms and proportionally. Banks, insurance companies, equity funds, venture capitalists, hedge funds--all are desperately looking for investment opportunities. They have more money than they can profitably, prudently put to work. Bernanke's explanations for the events that are about to unfold will be interesting. Will he blame Arab sheikhs? Rapacious corporations? Budget deficits? Trade deficits? Hedge funds? Sunspots? All of the above? Or will he have the courage, the understanding to point the finger at the institution he will soon be piloting?

Given his statements that gold is an obsolete, if not destructive, guide to monetary policy, Bernanke is not likely to recognize the inflation problem until it hits him--and the economy--square in the face. A year from now Greenspan's successor may, unfairly, resemble the ill-starred G. William Miller, whom Jimmy Carter appointed to head the Fed in December 1977 and who proceeded to stoke inflation to record highs.

Bernanke should let short-term interest rates float and simply mop up the excess liquidity until the price of gold comes down to a tad below $400 an ounce, a price still above the average of the past ten years. Sadly, such a timely, sensible approach is so beyond Bernanke's mind-set--not to mention that of most other economists and policymakers--that he'll never do it.

Like booze at a party, easy money should make for a good economic year. The morning-after headaches will start being felt by next Christmas.


Mitigating Inflation's Fallout
How severe the hangover is will depend on what the Bush Administration and the so-far fumbling Republican Congress can accomplish in the new year. Key to mitigating the damage of the about-to-worsen inflation is making permanent the tax cuts of 2003--or at least extending them for a couple of years. The reduction in both the capital gains tax and the personal levy on dividends was critical to the rapid economic growth--not to mention the $4 trillion increase in equity values--we've experienced since those cuts were passed. If markets come to believe that those crucial reductions will expire in 2008, equity prices will begin to be marked down in anticipation of this well before then.

Too bad the Bush Administration has decided to punt on major tax simplification, such as the flat tax. Imagine the benefits to our economic growth and competitiveness if we had a single 17% rate that when applied to personal income would kick in only after generous exemptions for adults and children. A family of four would owe no federal income tax on its first $46,165; there'd be no tax on savings, no Alternative Minimum (read Maximum) Tax and no death tax. For businesses the tax on profits would fall to 17%. And just as exciting, depreciation schedules would be eliminated for tax purposes. If a business made a capital investment, it could expense the outlay in the year in which the investment was made. Any losses could be carried forward until they were absorbed by future profits.

Sadly, the hash the White House made of reforming the Social Security system has turned this Administration and Congress cautious. The mistake here was simple: President Bush never put forward a single, comprehensive plan to transform Social Security from a generational-conflict-fostering economic drain to a capital-generating, wealth-creating, economic-illiteracy-reducing, better-benefits-for-all mechanism. Ideas for particular changes were floated from time to time, but these were never coherently pulled together. As a result people's worst fears festered--taxes would be substantially increased, benefits would be slashed, people would be forced to become speculators in the Enrons of the world, and Grandma would be tossed into the snow. How a once politically savvy Administration could make these fundamental errors regarding such an important, sensitive issue is astonishing.

Trade is another area to watch closely. Turbulent times can destructively stir up protectionist sentiments.

A mammoth Medicare drug entitlement is set to kick in this month. The Administration should propose significant subsidies to help those with low incomes instead of giving this benefit to those 65 and over, including seniors on The Forbes 400 rich list.

Since the Administration is not going to simplify the tax code, it might as well push for allowing individuals a tax deduction on the premiums paid for health insurance plans that have Health Savings Accounts. It should also permit individuals to buy health insurance sold in any state. New Jersey residents, for example, are currently barred from purchasing a policy available to those who reside in Oklahoma, thereby thwarting marketplace pressures that could lead to better insurance policies at lower prices.


We Are There
Rise to Rebellion--by Jeff Shaara (Ballantine Books, $15.95). Shaara's historical novels dramatically bring their characters and eras to life. This one covers the pivotal period of 1770-76, when the American colonies responded to Britain's increasingly heavy-handed attempts to tax them hard and control them ever more tightly, first with protests and then with war. As in his other masterpieces, Shaara gets into the minds of his characters and lets their thoughts move the story forward.

Shaara, a superb storyteller, easily shifts from the lofty to the mundane, as in his description of John Adams trying to prepare a cup of coffee. Bureaucratic intrigues, political maneuvering, debates and bloody battles all unfold seamlessly and credibly. Individuals are superbly drawn--and not only the biggies, such as George Washington, John Adams and Ben Franklin, but also others, like Sam Adams, John Dickinson, Joseph Warren and Massachusetts' pro-English governor, Thomas Hutchinson. Early battles, particularly the one at Breed's Hill (known to us as Bunker Hill), are described vividly and dramatically. The book ends as Washington eyes the British fleet coming into New York Harbor with thousands of troops shortly after we declared independence.

This is epic, heroic history, rendered brilliantly.



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