The Magic Formula of Economic Success

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It seems that we are in a period of economic decline. This might get a little tiresome eventually (it takes people longer to get fed up than you might think), and then maybe a few will start looking for solutions.

If I could send a fortune cookie to those future leaders – five, ten, or twenty years from now – it would contain the Magic Formula of economic success. Here it is:

Low Taxes
Stable Money

If you look at any of the great economic successes over the past two hundred years, you will usually find this combination. Likewise, most of the great failures have the converse: high (or rising) taxes, and unstable money.

Today, a rather energetic discussion of economic policy is taking place, but you will notice that almost nobody suggests anything that is in line with the Magic Formula. On the contrary, the trend is toward the opposite. Economic weakness begets heavy spending; heavy spending begets large deficits; large deficits beget a political trend toward higher taxes. They will eventually find out that higher taxes beget economic weakness.

President Obama has already outlined his preferences for a reversal of the Bush tax cuts, plus still higher taxes on upper-income earners, plus a removal of the upper-income cap on payroll taxes, plus additional increases in capital gains taxes. But this is just the beginning; there is serious talk of introducing a national VAT in the US.

What about the stable money part of the equation? The most stable money, historically, has always been produced by a gold standard. That is the gold standard’s purpose. However, beginning especially in the 1930s, a new ideology arose. We no longer wanted stable money. We wanted money we could manipulate, so we could fool people into doing things they would not otherwise do. Alas, this sort of thing has consequences, and they are usually not too pleasant. The US dollar has already fallen to 1/50th of its original value due to our belief in monetary manipulation. The next 50-fold decline might take place in a much shorter period.

Thus, we have higher taxes and, I expect, increasingly unstable money. On top of a dozen other things you could name. Do you see what I mean about an era of economic decline?

I know that many learned economists will say: “Yes, that is interesting, but we can’t afford a major tax cut at this time. Plus, we need all the help we can get from monetary policy.” This is what people always say in the early period of an era of economic decline.

The fact of the matter is that you can always reduce taxes. Some of the most brilliant tax cut strategies have come from governments in the direst situations imaginable.

Russia was a disaster zone when Vladmir Putin introduced a 13% flat income tax in 2000. Over the next seven years, the average worker’s salary (in US dollars) increased by an astonishing 30% per annum.

Germany was in even worse shape in 1949. In the years after the war, hyperinflation raged and millions died of starvation. Much the same was happening in Japan. Both enacted huge tax cuts in the early 1950s. Japan even went so far as to require a balanced budget by law. Both introduced gold-linked currencies at the same time.

This is the kind of thing that happens in the early stages of an era of economic success. The results were very much in line with Russia or China over the past few years. You’ll notice that Russia and China today have little interest in monetary manipulation, but are teaming up to establish an international currency regime that promises more stability than the mismanaged US dollar. Russian president Dmitry Medvedev even presented a 1/2 oz. gold bullion coin at the most recent G-8 meeting, as an example of the international currency of the future.

Why did Germany and Japan go this route? They did it because they finally got fed up. Once they got fed up enough, they started to look for answers. The answer was the Magic Formula, although they didn’t call it that in those days.

Politicians today, especially in the US, are nowhere near that point. They still think they can spend and tax and devalue their way… not to prosperity exactly… but to a continuation of the status quo. The status quo in which they are somewhere near the top.

Maybe one of them is reading this essay right now. If they hadn’t heard of the Magic Formula before, they know about it now. And what are they thinking?

“Hmmmm, some kind of libertarian crank by the looks of it.”

It’s just too early in the process. Louis XIV’s finance minister Vauban wanted to replace the hideously corrupt and oppressive French tax system with a simple 10% income tax. Louis fired him.

Maybe Louis XIV himself was corrupt and oppressive. Plus, he was already the Sun King. Why fix what ain’t broken? Taxes got higher and higher, until finally the French “voted” for lower taxes by exterminating the aristocrats altogether.

The French example is from a wonderful book by Charles Adams, called For Good and Evil: the Impact of Taxes on the Course of Civilization. Adams also offers an example from ancient Egypt:

“Scholars have tried to determine what went wrong in Egypt under the Ptolemies, when an empire that had survived for over three thousand years simply withered and died… Egypt had suffered no military disasters, famines or plagues…”

The most impressive analysis of Egypt’s demise came from the great Russian scholar Rostovtzeff… Rostovtzeff felt that the continual and unabated tyranny of Egyptian tax collectors produced a nationwide decline in incentive. Egyptian workers and farmers lost their desire to work – agricultural lands fell into disuse, businessmen moved away, and workers fled. Sound money disappeared as a raging inflation destroyed what capital there was. The land became filled with robbers who wrecked commerce and brought fear and despair to the populace.

Remember the Magic Formula. It will come in handy someday.

Regards,

Nathan Lewis
for The Daily Reckoning Australia

Nathan Lewis
Nathan Lewis is the author of Gold: the Once and Future Money, published by Agora Publishing and J. Wiley. He runs an investment fund in Westport, Connecticut.
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16 Comments on "The Magic Formula of Economic Success"

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Lachlan
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Six to ten thousand years of civilisation. We prove over and over that man just cannot give peace and prosperity to his own kind for any length of time. Because mens minds continuously turn to theft. We will steal from our fellow man because we fear that we wont be provided for. Our inconspicuous enemy is fear and doubt. Our masters fear for their own well being. They steal from us and increase their own power and control to protect/enhance that position. People fear for their own well being. We turn to our masters for protection. We give up freedom… Read more »
Biker Pete, St. Simeon, Quebec
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Biker Pete, St. Simeon, Quebec
“In God We Trust”. Printed in green capitals 2mm high, just above ONE, 20mm high, on the back of the cream US buck. Once the most trusted currency on earth, Lachlan. Are the _words_ enough to save it?! ;) In fact God helps those who help themselves. The latest religion, the ‘Law of Attraction’, in which we simply _think_ very positively… and _attract_ wealth and prosperity… is appealing, but fatally flawed. Conversely, negative energy actually reduces our likelihood of success. You only have to read back through a few days’ posts, to see which few unhappy souls preach fear, pray… Read more »
Ross
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Biker , I liked your post. I’m also a happy soul, just ask my daughter, but I am also preaching fear and fear itself is not a bad thing unless it clouds your judgement. There have been plenty saved by it through the millenia

Lachlan
Guest
Gidday Biker Enjoyed your post. Just to elaborate, Im not a bling believer either, its a childish (dependent) type of philosophy… and so agree with everything you say except to identify God as my provider rather than cosmos. I also believe that nothing material is guaranteed in this world including the USD :) in particular. Since nothing is guaranteed (remembering neither us believe in bling) its important then to realise that no matter what good or bad things befall us that we can remain “relatively” unchanged. After suffering, we can choose to remain thankful for what we do have (in… Read more »
Lachlan
Guest

Ok so good fear and bad fear…two types.
*Good fear….maybe fear of the tangible eg “ooooh theres a bus about to hit me”. Jump out of its way. Result…fear saves me.
*Bad fear….fear of the intangible. eg “I just never seem to get what I want in life, poor me. Because of this I’m afraid I probably never will. I’ll just have to take what I want off somebody else.” Result fear gets me a jail sentence.
By the way Im not talking from personal experience…. at least per example #2. :)

Ned S
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All fair comments Lachlan. But if I find myself living in a country where I have no alternative but to trust in a higher power (be it god or government), I sure do hope I can find another country to live in that’s better.

Lachlan
Guest

Evening Ned.
Ned I often wonder whether your computer doesnt do smiley faces for some reason or whether you could use tuition, maybe from Biker Pete. He showed me how to do a little while ago.
Delayed thanks for that Biker. :)
Yes Ned our country is still lucky but not headed in a favourable direction. Much natural wealth, rugged beauty, plenty great people….alas…

Biker Pete, Ste. Anne-des-Montes, Quebec
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Biker Pete, Ste. Anne-des-Montes, Quebec
G’day, Ned, Lachlan and Ross. More by accident than design I discovered some time back that if I typed a colon then a closing bracket, I could create a smiley. :) A semi-colon and a bracket created a wink. ;) A colon and an opening bracket created a frown… not a symbol I’ve used much. Ross, I gave the Man a capital, you’ll see… and I appreciate the reference to Job! I used the term ‘cosmos’ because that’s how my two young sons explained a series of my actions they’d observed before their teens: “Dad’s repaying the cosmos.” I liked… Read more »
Biker Pete, Ste. Anne-des-Montes, Quebec
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Biker Pete, Ste. Anne-des-Montes, Quebec

Quick footnote: Sorry Lachlan, I attributed your comment to Ross. And Ross, I agree about the ‘fear’ issue. A warning shot or two across my bows from DR, a couple of years ago, helped us shift asset classes in a timely and orderly fashion…! :)

Lachlan
Guest

Biker must be global roaming. Ohwell Ned I think the correct sequence is
space bar,colon,close bracket.
Wallah :)

Biker Pete, Rocher Perce, Quebec
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Biker Pete, Rocher Perce, Quebec

Yep, still global roaming, Lachlan. Colon close bracket works pour moi, but I’m on a Mac.* :) (I’m actually on a MacBook, on the beach, gazing at the largest lump of rock I’ve seen since Uluru, which is sticking up right out of the Atlantic, like an immense golden iceberg. I’m drinking a glass of Caleta Reserva because good Aussie reds are hard to find in far north-eastern Quebec. It’s 30 degrees. Good fun, but I wouldn’t trade it for home.)
* Never have been PC, in either sense, according to the T & S.

Lachlan
Guest
Your answer wasn’t on the board when I posted my last Biker. Anyhow Ive never had a Mac and dont know if theres a benfit to me but might have a look see when I get my next computer. Just got a laptop PC now. When I started trading I wondered if I could get a computer/connection which would stay connected in various remote places. You seem to be getting around alright with your connection (a super go anywhere connection?) Maybe Australia is poorly served in this sense…relatively speaking. Ive tried three wireless systems all of which are hopeless. Also… Read more »
Greg Atkinson
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Lachlan when it comes to wireless Australia is not well served. Up here in sunny Japan they are rolling up high speed wireless on the high speed train (Shinkansen)..no easy task when moving along at 250km/h + and through a lot of tunnels. I use to have a certain wireless service in Australia that was suppose to be no fuss and portable, but it kept dropping out even at home!

Ned S
Guest

Drag Ned out of the dark ages is it gents? Hmmm … Come in spinner … I’ll be mortified if all I end up posting is a colon and a close backet :) – Which is what it surely looks like to me right now! ;)

Lachlan
Guest

Hooray Ned! Have we increased Oz GDP by saving Ned time on smiley face production? The answers to the GFC right here at DR.
That makes me laugh Greg because I went through similar experience. Got my wireless systems, hooked them up and then found I could barely use them in the house let alone in the forests of SEQ. Sounds like we’re all in the dark ages Ned…in OZ that is.

Biker Pete, Caraquet, New Brunswick
Guest
Biker Pete, Caraquet, New Brunswick

Wireless has worked well for us since 2005, Lachlan. Each year we’ve been abroad we’ve found improved access. It’s true we’re a little behind in Oz, although we’ve set it up at home to give good coverage across our ten acres… .

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