Economy & Budget

Financial Reform Needs Free-Market Approach

LAS VEGAS — Legitimate financial reform that would feature free-market principles and “sensible” capital requirements on banks is missing from the Dodd-Frank bill passed July 1 by the House, said Steve Forbes, CEO of Forbes Inc., during his keynote speech Thursday here at FreedomFest.

The so-called “financial-reform” legislation is expected to be taken up by the Senate next week. The bill largely won support along party lines, with Democrats favoring the initiative of President Obama and Republicans objecting to key provisions that included assessing a $19 billion tax on banks and hedge funds, creating a consumer protection agency under the control of the Fed, and forming a council of regulators to oversee risks to the system.

The reality is that the Fed’s irresponsible monetary policy of slashing interest rates to historically low levels fueled the nation’s financial crisis that featured a housing bubble that later turned into a bust, Forbes said. Increased money supply is the equivalent of an additional tax, he told the attendees.

If cheap money was the key to creating wealth, Zimbabwe and Argentina would “own the world,” Forbes said.

Responsible financial reforms would ensure that banks maintain sufficient capital and adequate debt-to-equity ratios, abolish money-losing Fannie Mae and Freddie Mac, and set limits on the use of risky derivatives by financial institutions, Forbes explained.

Many people are sympathetic to the ideas of free markets but sustainable economic growth also requires low tax rates and simple rules for an entrepreneur to start a business, Forbes said.

Key to Success

“You only succeed in a free market if you provide a product or service that somebody else wants,” Forbes said.

One reason for the healthcare crisis in America is that the sector does not have adequate competition, Forbes explained.

“In any other part of the economy, increased demand for a product is considered good for business,” Forbes said. “We don’t have a free market in healthcare.”

People usually don’t ask doctors and hospital staffers what anything costs, since third parties typically pay the bills, Forbes said.

Competition in providing contact lenses and Lasik eye surgery are examples of how free-market principles can bring down prices in healthcare services, Forbes said.

Other speakers at FreedomFest Thursday also voiced concerns about U.S. policy, the economy and the financial markets.

Going the Way of Greece?

By the middle of the next decade, the United States could have a debt situation that resembles fiscally troubled Greece, said Richard Rahn, a senior fellow at the Cato Institute and chairman for the Institute of Economic Reform, who moderated a provocative panel discussion Thursday.

The key to growth and prosperity is economic freedom, said Jim Gwartney, director of the Stavros Center for the Advancement of Free Enterprise and Economic Education. Countries that follow such a “recipe” enjoy economic growth, he added.

“We need a political revolution to move us back to economic freedom,” Gwartney said.

Instead, expect government to become bigger, Gwartney said. One reason is a huge U.S. debt-to-income ratio that keeps worsening, he added.

Anticipate a 50% increase in the U.S. population among those who are 65 years of age or older, Gwartney said. An aging population tends to lead to an increase in government expenditures due to entitlements such as Social Security, he explained.

Undermining Private Investment

Another threat is that federal policy swings undermine private investment, Gwartney said. Policies that allow bailouts for banks and auto companies, and “cap-and-trade” undermine economic freedom and hamper growth, he added.

The world is dividing itself into three parts: developed countries that need to curb deficit spending or suffer economic consequences, less developed countries that are moving toward economic freedom, and less developed countries that are moving away from economic freedom and will regress, Gwartney said.

Keith Fitz-Gerald, a global investment expert, said 75% of economic activity now takes place outside of the United States. As a result, he encouraged audience members to consider investments that tap growth in foreign markets.

If you want to invest in U.S. stocks, look for American companies that have substantial foreign sales and are growing, said John Dessauer, the editor of John Dessauer’s Outlook and the author of two books about global investing.

Senate Candidate’s Warning

Peter Schiff, chief global strategist at Euro Pacific Capital who also is seeking the Republican nomination in Connecticut for the U.S. Senate, warned that he expects a “deflationary depression.” He agreed with Forbes that the financial crisis in America took root when the Fed’s interest-rate cuts led to a “borrowing and spending binge.”

Consequently, the U.S. savings rate “went negative,” Schiff said.

“We didn’t grow anything but our debt,” Schiff continued.

Rather than allowing people to “sober up,” the government is offering more spending and debt in hopes of easing financial pain, Schiff said.

Alexander Landia, chairman of Merryk & Co., cautioned against government bailouts, especially those that do not force lenders to accept consequences for poor business decisions. The recent bailout of banks that bought Greek debt did not require the lenders to take “any haircut,” he added.

Some of those banks enticed Greece to assume additional debt through “off-balance sheet schemes,” Landia explained.

Markets rallied Wednesday after it was announced that “stress tests” would be applied to European banks to deter excessive risk taking in the future, Landia said.

As for BP and the financial consequences of its gulf oil spill, Landia put the situation into economic context by explaining that a big reduction in the price of oil from a peak of $147 per barrel in July 2008 to today’s $76 per barrel saved $1.5 trillion.

“It is bigger than any government stimulus package,” Landia said.

Robert “Bob” Bauman, who had been a libertarian member of the U.S. House of Representatives before Rep. Ron Paul (R-Texas) was elected, was blunt in his criticism of policymakers.

Led by Idiots?

“Generally speaking, government is run by a bunch of idiots,” said Bauman, who now serves as legal counsel to the Sovereign Society

However, Bauman added that crisis provides an opportunity to make constructive changes.

“Freedom offers endless possibilities,” Bauman said.

Bert Dohmen, president of Dohmen Capital Research Institute Inc., said that he recommended bearish exchange-traded funds (ETFs) in late 2008 and he predicted another such opportunity will occur later this year.

Dennis Slothhower, chairman and chief investment officer of Alpine Capital Management, said he is staying 100% in cash because he is “afraid” of the market.

“If you don’t manage risk, risk will manage you, Slothhower said. An investor needs to identify risk and learn how to avoid big losses by exiting markets soon enough to protect their capital, he added.

A transitional phase in the market occurs when high-frequency trading causes markets to go both up and down, Slothhower said.

The second half of this year could be quite severe on the downside, Slothower cautioned. A pattern of lower lows and lower highs is starting to occur in the equity market. Such times present shorting opportunities in stocks and ETFs, he added.

Unsavory Buffet Table

“Everybody in this room is on the buffet table, not at the buffet table,” said Ty Andros, CEO of Traderview, a money management firm that focuses on alternative strategies.

Great countries rise on production, Andros said. Empires die the opposite way by consuming more than they produce, he added.

“The Western world’s financial and currency systems are going to go extinct,” Andros said. People need to gravitate toward gold and silver to store their wealth, he advised.

“I think the next decade will bring crisis in abundance,” said Rick Rule, founder of Global Resource Investments Ltd. “The key is to turn crisis into opportunities.”

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