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On today’s edition of Coffee and Markets, Brad Jackson and Ben Domenech are joined by Francis Cianfrocca to discuss how the upheaval in Libya and the Euro Bond debate will effect the markets. Then we’ll ask Francis when the next recession will hit, and oh yeah, Brad and his wife had a baby boy last week.

We’re brought to you as always by BigGovernment and Stephen Clouse and Associates. If you’d like to email us, you can do so at coffee[at]newledger.com. We hope you enjoy the show.

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Obama faces worst-case 2012 scenario

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For once, top Obama economic advisor Larry Summers got it right. Warning opponents of the big tax-cut deal, Summers told reporters, “Failure to pass this bill in the next couple weeks would materially increase the risk that the economy would stall out and we would have a double-dip recession.”

Too bad Mr. Summers didn’t advise the president to cut taxes across-the-board two years ago, rather than push for the misbegotten $800 billion government-spending package. That policy dismally failed to ignite a real economic recovery or to lower the unemployment rate.

But it’s never too late to promote good policy. And echoing Summers, in recent months any number of demand- and supply-side economists warned of a double-dip (or nearly so) unless the Bush 2003 tax cuts were extended. The economy would be demoralized from a rollback of incentives to work, invest, and take risks. Plus, roughly $600 billion of cash (including the alternative minimum tax) would be drained from the private sector.

Whether Obama is really changing his stripes and abandoning class-warfare, big-government spending remains to be seen. But at least he is out there defending the huge tax-cut package, which is pro-growth, along with a South Korean free-trade deal, which also is pro-growth. Certainly it’s a turn for the better for the White House.

In the wake of the tax-cut announcement, a number of Wall Street forecasters are upping their growth estimates for 2011 and beyond. The consensus seems to have lifted real GDP by nearly a full percentage point. And if the economy can grow by 3.5 to 4 percent, the likelihood of a sizable decline in unemployment literally grows stronger.

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Corporate profits are at all-time highs and bond rates in the Treasury market are virtually at record lows. That’s a good combination for stocks, and it helped trigger a 255 point rally in Wednesday’s trading. What’s more, a surprisingly positive read on the ISM August manufacturing report delivered a strong blow to the double-dip recession pessimism that has plagued investors for many months.

Without question, the jobs picture is going to remain cloudy. There’s just too much uncertainty over the economy and the tax-and-regulatory threats coming out of Washington. Businesses can’t be sure about the costs of hiring. Meanwhile, over in housing — our other weakest sector — an inventory glut threatens further price declines.

But make no mistake about this: Businesses, at least the publically owned ones, are in very good shape. U.S. firms scored a record $1.2 trillion in profits during the second quarter and are sitting on roughly $2 trillion in cash. Our private-sector companies are resilient, and they have recovered significantly from the economic plunge.

And while their hiring is still behind schedule, they have begun the process of investing in equipment, software, and other capital goods. Business investment in the June quarter rose 16 percent above year-ago levels. This is all to the good. Healthy businesses are crucial to the stock market as well as the overall economic outlook.

In fact, since 2001, business profits have doubled, even while the stock market dial has hardly moved. If Washington can just keep its paws off of business and let market processes work, firms will continue to prosper domestically and internationally and will eventually pick up their hiring.

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Economists and pundits, who contend that the Federal Reserve System has little room to maneuver in using monetary policy to jump-start our anemic economy, often have claimed that America is mired in a Keynesian “liquidity trap”, a situation in which the demand for money is unresponsive to changes in market interest rates.

After all, those commentators emphasize, the Fed has adopted a target for the federal funds rate (the interest rate charged on overnight interbank loans) of between zero and 0.25 percent. The implication is that further reductions in that rate will have little or no effect on the incentives of businesses to invest in new plant and equipment or of consumers to borrow in order to finance the additional spending necessary to raise GDP growth above the (recently downwardly revised) estimate of 1.6 percent during the second quarter of 2010.

But those commentators overlook or ignore the easily verified reasoning of John Maynard Keynes, who defined a liquidity trap in terms of long-term rather than short–term interest rates. The long-term (ten- or 30-year) rate on Treasury securities now runs at about three percent, meaning that the Fed still has arrows in its quiver. Unfortunately, however, those arrows, the use of which would demand the central bank engage in further “quantitative easing”, requires it to purchase more under-performing, “toxic” assets from banks and other financial institutions that lent money to homeowners who could not repay their mortgages. Engaging in such transactions places more bad debts on the Fed’s balance sheet, constrains its ability to conduct monetary policy in the future and raises the specter of higher rates of future price inflation.

In his recent speech at Wood’s Hole, Wyoming, Fed Chairman Bernanke was right to say that economic recovery cannot depend solely on the policies of the central bank over which he presides. But the fiscal discipline (spending and tax cuts) required to achieve that goal is incompatible with the vote motives of incumbent politicians or their challengers for political office.

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Will higher tax penalties on investment really spur jobs and faster economic growth? Most commentators would say no. It’s really a matter of economic common sense. But Tim Geithner says, Yes!

Speaking to a group in Washington this week, the Treasury secretary said that extending tax cuts for the wealthiest Americans would imperil the fragile economic recovery. He argued that government needs the revenues from those top-end tax hikes. So failure to raise taxes would harm growth. And then he went on to say that the trouble with the wealthy is that they save more of their tax breaks than do other groups.

Okay. Are you confused now? Most people would be.

Let’s start at the top. The coming tax bomb would raise the top marginal tax rate on capital gains from 15 to 20 percent, on dividends from 15 to 20 percent (or perhaps all the way to 39.6 percent), and on top incomes from 35 to 40 percent. Meanwhile, the estate tax could go as high as 55 percent.

Now, it is indisputable that cap-gains, dividends, and estates are essentially investment. What’s more, most successful earners who pay top personal tax rates are by near all accounts the folks who are most likely to save and invest.

But Mr. Geithner is suggesting the economy doesn’t need more saving. This thought was echoed by Jared Bernstein, a top White House economist, who told me in an interview that the saving and investment multipliers for economic growth are way below the stimulative effects of government transfer payments, such as more aid to state and local governments and further extensions of unemployment benefits.

Echoing that thought, the Senate this week voted to approve $26 billion in aid for state and local governments — partly funded, by the way, by an $11 billion yearly tax increase on the foreign earnings of U.S. multinational corporations. Here, too, a tax on profits is a tax on investment. The Senate also rejected an amendment by South Carolina Republican Jim DeMint that would extend all the Bush tax cuts.

In effect, pulling all this together, the position of the Democratic party in power in Washington is that transfer payments (taxing and borrowing from Peter to pay Paul) are good for growth, and that investment is bad.

Go figure.

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The media continue to report dismal economic news, raising the specter that our teetering economy may fall back into a “double-dip recession.” Continuing high unemployment is the biggest worry for most Americans. The percentage of working-age people in the labor force last month fell to 64.7 percent—the lowest figure in a quarter century.

You would think that the administration’s top priority, then, would be to foster a pro-investment, pro-hiring business atmosphere. You’d certainly not expect them to pursue policies that could push any impending recovery, fragile at best, over the “tipping point” and down into another economic chasm.

That, however, appears to be just what they’re doing.

The administration’s entire agenda—from “stimulus” spending, to government-run healthcare, to takeovers of financial institutions, to higher taxes—has spread paralyzing uncertainty throughout the investment community. But that hasn’t caused them even to slow down, let alone change course.

Consider three job-killing measures imposed by this administration in a single area: environmental regulation.

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This whole debate about government stimulus versus austerity, and the impact of these policies on economic growth, misses a key point: It is business, not government, that creates jobs.

The economic power of business is the missing link in the faux debate that is now raging over spending and deficit policies. A brief look at the recent jobs report for June tells this story. After spending more than $1 trillion through so-called government stimulus, we are at best experiencing a grinding and anemic jobs recovery. Private payrolls are growing slowly. The workweek is again shrinking. And average hourly earnings have declined. The unemployment rate dropped to 9.5 percent, but that’s because 650,000 people left the labor force.

Most troubling, the household survey, which captures small owner-operated business employment, dropped 300,000 following a decline last month. In other words, this leading indicator is moving in the wrong direction. More generally, recent economic data suggest that the rate of recovery could be slowing to only 2 percent, or even less. Some fear a double-dip recession.

So what about all this stimulus spending? Well, it hasn’t worked.

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