Paul Krugman is on again today about the disappearing middle class, and how the Bush tax cuts are and always have been a huge, unfair giveaway to “the rich,” whoever they are. Because I happen to remember that the Bush tax cuts actually were an across-the-board cut in marginal rates, together with strong reductions in taxes on capital, I wondered how Krugman gets from there to considering them unfair.

Well, of course it’s because high-income people pay more taxes than lower-income people. A LOT more taxes. So any change in marginal rates necessarily affects them more, whether you raise rates or cut them. Clearly enough, Krugman doesn’t have a problem with low tax rates. He has a problem with the fact that some people earn a lot of money.

That got me wondering why we have so much income inequality in the first place. I don’t think there’s one simple answer to that question, but a lot of it comes down to the amount of risk you take.

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Paul Krugman has just declared the onset of another Great Depression. To him a Depression is characterized by a long-term deflationary trap, but that’s not the reason Depressions are to be avoided. Depressions are bad because of long-term unemployment, which tears at people’s lives and at the fabric of society. So far, I’m with him. After all, to the best of my knowledge, I’m the first one to have used “Great Depression II” in print, back in autumn of 2007, when the stock market hit its all-time high and RedState readers responded by beating me up for bashing the Bush economic record.

Krugman claims the paternity of the New Depression in the name of the Keynesians. He says that it’s been triggered by the policy errors of the Europeans, who refuse to extend fiscal stimulus, and of the Republicans, who refuse to allow Congress to funnel more money to state and local governments. He’s going to be eating out on this for the rest of his life, because the long-term economic weakness facing us is the real thing, and his statement that we caused it by not stimulating enough will never be falsifiable. (When the crisis started, he was still insisting that only WW2 created enough government borrowing and spending to end the Great Depression.)

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In regard to the battle over changing the tax treatment of carried interest: I don’t want to see capital gains taxes raised under any circumstances, and in fact I think they should go all the way to zero. But I’m not inclined to fight too hard to keep carried interest taxed as capital gains rather than ordinary income.

For one thing, the carried interest to the general partners of private-equity and venture-capital firms is usually a gain that they made with other people’s money, not their own. They don’t face the downside as their limited partners do, so their participation doesn’t really rise to the level of risk capital. When carried interest is liquefied, it takes the outward form of capital gains, but in economic terms, it’s actually compensation paid by the limiteds to the generals.

For another thing, I don’t buy that PE creates economic growth. Leveraged buyouts are one of the ways that companies fail in our distorted tax system, which double-taxes and sometimes triple-taxes corporate profits. Companies don’t become valuable as they make more money. They become valuable as they grow. That’s because the capital appreciation of a business is taxed far less heavily than its earnings.

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Most European stock markets have opened down almost 3%, with some down almost 4%. US stocks are down about 3.5% there, the equivalent of almost 400 Dow points. The 30-year bond yield is now a hair above 4%.

I heard people yesterday speaking of a bit more calm in US credit markets than has been the case in recent days. There are good signs here and there in various markets. The US is looking better than the rest of the world at this point. Europe is… Europe. China fears the loss of export markets as the euro falls. Meanwhile, Japan, Korea and China all face war warnings from the Dear Leader.

This situation has a very different feel from the summers of 2007 and 2008. In my view, there isn’t nearly as much risk of widespread insolvency, as many financial institutions have spent the past year and a half buying mostly government-guaranteed assets and repairing their balance sheets. But there’s very little reason to expand risk-taking activities as the global economy deflates, and there is much fear of continued volatility. The volatility by itself increases market spreads and makes trading harder to do.

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As I wrote here yesterday, we ‘ve just seen the remarkable spectacle of more than a dozen fractious finance ministers come together to puncture the risk of a Lehman-style market debacle. Taking a page out of Ben Bernanke’s playbook, they cobbled together and announced a package of 750 billion euros (nearly a trillion dollars) in liquidity guarantees.

Think about that number. It’s twice the size of Greece’s economy.  This wasn’t targeted at Greece. It was targeted at last week’s quickening alarm over the possibility of an interbank liquidity crisis.

I call this the Bernanke Doctrine. You respond to disordered credit markets by making short-term liquidity available in essentially unlimited size, as soon as you sense the beginning of the disorder. Although Bernanke got the idea from his studies of the dynamics of the banking crises that preceded the Great Depression, it makes all the more sense in an intensely interconnected world that trades at the speed of light.

How did it work? Well, you saw a nearly 8 percent relief rally in European stocks yesterday, after about 4 percent in Asia. US stocks rose about 4 percent. Interest rates on notes and bonds rocketed skyward yesterday, the euro briefly traded stronger than $1.30, and corporate debt spreads tightened.

So as of early yesterday, this looked like a brilliant performance for Euro-TARP.

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Holy smokes, people. They said it couldn’t be done. But it looks like the European finance ministers decided to get together and disprove everyone who has been saying for days now that they couldn’t even come close to acting in a coordinated way.

They pulled 440 billion euros out of a hat, as a bailout fund for sovereign states. The IMF kicked in another 250 billion, and there’s another 60 billion coming from the EU itself. It’s just under a trillion dollars.

You’re not going to believe what you see when Wall St. opens this morning. A rally is going on in European stock markets like nothing I’ve seen there before.

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The situation in Europe in regard to Greek debt may be entering a new phase, and I’m talking about something more serious than tear gas and Molotov cocktails.

Now that the EU and the IMF have agreed on (and the key legislatures have ratified) a 110 billion euro bailout for Greece, the question has become: will it be enough?

Greece faces unusually severe austerity budgets, and probably a deep recession. Even with reduced government spending and a bailout package, it’s possible that they won’t be able to generate enough economic growth to stay ahead of their debt. In fact, that outcome is likely.

Attention will soon shift to the large European banks that are the holders of much of the Greek debt. If a default should occur or even appear more likely over the coming weeks and months, those banks will have a hard time doing business. And after the last financial crisis, many don’t have the balance sheet strength to weather the storm easily.

In my view, the only possible outcome that isn’t precluded by political problems (aka lack of leadership), is for the European Central Bank to print enough new money to allow the value of the euro to drift lower, possibly as low as parity against the dollar.

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We’ve had a remarkable run in US notes and bonds over the past several weeks. The economically-sensitive 10-year note briefly yielded more than 4% in mid April. After an astounding rally yesterday, buying in the 10-year continues this morning, and its yield is down to 3.57 as I write.

I’m at a loss to convey the magnitude of this move in such a short time. Unless you’re a capital-markets obsessive like me, it’s hard to sense how big this is. Coming at a time when the euro is widely expected to drop sharply in value and Asian markets appear to be very overextended, the rally in Treasury debt has to be interpreted as a broad turn away from risk.

Why? The news stories are unanimous in blaming the ongoing and very serious situation in Greece. I’ve been sounding the alarm in this space about the weakness of Greek debt for months now. The underlying problem there is worse than elsewhere, and there are somewhat different drivers for it, but it still is a widespread problem: too much deficit spending by governments. To state the problem even more broadly: too much spending by governments, period.

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The healthcare law is the first step in what will probably become a sustained movement to shift the balance of economic power in the US from producers to consumers. It’s going to be accomplished by steadily increasing the tax burden on high earners and expanding benefits to those who earn relatively less.

We’ve seen this before. It was more or less the effect of the labor movement in the middle of the last century. In the decades after WW2, we dominated global economic output (about one-half the total, compared to about one-third today), and trade was a much smaller part of our economy than it is now. In this relatively closed system, it was possible for unions to systematically increase the cost of labor. Labor historians, ignoring the effects of technology-driven productivity improvements, will tell you that this shift in wealth is what created the great American middle class.

The Reagan Revolution shifted the balance back toward laissez-faire and a more market-driven distribution of income, which has its own distortions. The Obama Revolution, and I’m not hesitant to call it that unless there’s a sustained backlash that goes well beyond the readership of this site, is a swing back in the other direction.

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The major health insurance and provider stocks leaped upward on the open, as expected. (They just acquired 32 million new customers in the most ideal way: it’s now illegal not to buy their products.) They all came back down again on some initial profit-taking, and now they’re drifting back upward again.

Big Pharma stocks started strong and stayed strong. Devices are looking steady. Capital markets are steady, with notes and bonds somewhat higher.

There’s nothing wrong with state capitalism. As long as you’re in the right position to profit from it.

About the value of China’s currency: we all know it’s undervalued. The Chinese know it’s undervalued. They can see it in consumer-price inflation, which is now up between 2 and 3 percent after being subdued for much of 2009. They can see it in a 15% jump in housing prices in some cities. And they can see it in the growing concern among ordinary Chinese about the falling real value of their savings and their ability to keep up their headlong dash to prosperity.

For all the talk about China powering a global recovery on a flood of government-driven investment, Chinese authorities have been steadily preparing the country for some tightening in bank lending and monetary conditions. They overstimulated, and they have to get this inflation under control. People are even starting to mutter darkly about a Chinese financial crisis caused by terrible credit quality among the (rampantly corrupt) local government authorities who borrow heavily against land to finance investment, using the central government’s credit.

Against this backdrop, we had one of the mainstream media’s patented story clusters this past week, complete with heavily-publicized statements by favored pundits, innocently timed to coincide with statements by policymakers. Of course, none of this ever happens by design, since we all know the media are objective and only report what they see. PR has nothing to do with it.

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Can this be for real? The Democrats are folding student-loan reform into the health bill so it can be enacted without 60 votes in the Senate.

I’ve written about this here. There’s been a lot of talk about student-loans since the current Administration came to power. The two key features that reportedly will make it into the healthcare legislation are:

1) Putting an end to the subsidized private student loan industry. Citibank, Sallie Mae and hundreds of others will be out of this business (except possibly as servicers rather than finance providers). From now on, the money will go directly from the Federal government to schools.

Senator Tom Harkin says this step is long overdue to stop wasting the taxpayers’s money. I say that if the government really wants to be a bank, they should first prove how they’re going to be any better at it than real banks are.

2) Sharply increasing the maximum amounts of Pell grants for low-income students, and automatically indexing the maximums for inflation every year. Some eight million Pell grants are awarded each year. Economists have been saying since I was in college that federal supports for higher education are the reason that, as with healthcare, the costs have been rising at far more than the general rate of inflation for decades now. We’re going to be kicking those cost increases into a higher gear now.

Why attach this thing, which upends and federalizes a quite substantial industry, to the on-again, off-again healthcare reform effort? That’s easy. To avoid both a public debate of the issue, and also the need to get 60 votes to pass it in the Senate.

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Barack Obama came to office promising universal healthcare, to end the carbon economy, and to fix education.

Numbers one and two were clear enough, but we’ve never gotten too much insight into number three, beyond Education Secretary Arne Duncan’s “Race to the Top” program. (The latter is essentially a remake of No Child Left Behind.)

On the finance side, the student loan industry is populated by Citigroup, Sallie Mae Inc. of Indianapolis, some other large players and hundreds of smaller ones. A year ago, Obama’s people quietly made clear to people in the industry that they could expect the government to take over their business. That meant specifically that banks and institutions like Sallie would be forced out of the business of providing subsidized finance for student loans.

What’s your obvious move, faced with something like that? You scramble to convince the government that you deserve to become a servicing provider to them, giving up the financing business in favor of a lucrative (and risk-free) business originating loans and handling the payment streams.

That is attractive to the government because it saves them the trouble of standing up a whole new student loan bureaucracy. They’ll still stand up the bureaucracy, of course, but now all they’ll need to do is demand lots of unreasonable reports and audits from the servicers who used to be finance providers.

But why go to so much trouble, on top of kicking in the teeth of yet another private industry?

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The only explanation I can think of for this is that Arnold is still nominally a Republican. His emergency budget plan for the state of California builds in an expectation of funds from the current and/or the next Federal stimpack.

Standard & Poor’s observed, rationally enough, that there’s no guarantee that Obama will write over so much of your and my money to California, so they downgraded the state’s debt to A-, one of the lowest investment-grade ratings. That means California has to pay a lot more money in interest every time they borrow, and will have fewer investors available to lend to them. Which of course makes their fiscal crisis all the worse.

Now you’d think California would be too big to fail, especially since they reliably give 55 electoral votes to every Democratic presidential candidate. Bill Clinton, as President, seemed to spend as much time in California as he did in Washington.

But today, David Axelrod was quoted as saying that he recognizes California’s problems, but can’t solve them all from Washington. To recall a famous line from the Seventies: Drop dead!

Maybe Obama figures he can count on California’s votes no matter what. Or maybe he wants to spite Schwarzenegger.

2009 was one of the very best years in history for the financial industry, with over $50 billion in profits for the top half-dozen firms alone. Forget for a moment about the fact that this industry was literally saved from death with taxpayer dollars. The real question is, what are they there to do?

The short answer to that question is that the financial industry exists to make capital available, and to allocate it efficiently to productive uses in the real economy.

Instead, what did the financial industry do to make its money? The Wall St. firms ran proprietary trading programs as never before, and they raked in huge fees underwriting issues of debt by the largest corporations, who used the money to improve their balance sheets but not to invest in new productivity.

The old-fashioned banks spent the year lending Fed funds to the Treasury, profiting risk-free from the steep yield curve.

In short, the provision of capital and sound allocation decisions delivered to the real economy fell far short of justifying the financial sector’s huge profits. As it has been for some time (at least two decades), this industry, in significant measure, is a parasite.

When will that change? As soon as the industry stops being so good at manipulating the political process and the regulators, and as soon as Washington stops needing Wall St and large banks to finance its headlong plunge into control over more and more of the economy.

Some major news has been hitting global financial markets hard over the last day or so: there is a prospective default by Dubai World, which is an investment vehicle operated by the second-largest of the seven United Arab Emirates.

It appears that a total of about $80 billion in debt is now at risk. About $10 billion of that is subject to rollover in the very short term, and may not be fully repaid. Major holders of the assets include HSBC, the London-based banking giant; the Royal Bank of Scotland; Japan’s Sumitomo; and others. None of these organizations is in a position to sustain another big hit to capital. RBS, in particular, has been all-but-nationalized by the UK government.

Until the financial crisis got really bad a year ago, Dubai had been on an ambitious campaign to become a global center for finance and high-end real estate. The original funding came from oil-rich Abu Dhabi, the largest emirate in the UAE. (Dubai has no oil of its own.) There are stories that Abu Dhabi decided to pull the plug on what is now not looking like a good investment story.

I’m still trying to figure out what the real impact is here, a process which may take some time because many people won’t be in the office today. $80 billion is a relatively small default in the grand scheme of things, but it is a sovereign default, and if it results in any kind of sizable loss-recognition by Dubai’s bankers, then that’s a hit to capital, and no one needs that right now.

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I think of the RedState community as my extended family, and I’m grateful to all of you for reading my past missives on markets and finance. I’ve been all but absent from the front page for months now, and I owe you an explanation.

First, my businesses have been performing very well this year, and being a CEO is time-consuming. Second, and more interesting to most of you, is that I’ve bitten the poisoned apple of electoral politics.

My wife, Paula Hostetter, was engaged as the campaign manager to Angelo Maragos, a young businessman who embarked on the seemingly quixotic task of running as a Republican for New York City Council. I got sucked in because a political campaign needs management-type people who can build a strong team quickly, and there I was.

I’m tremendously proud of Paula, who has run a tough, disciplined campaign against the longest possible odds (more on that in a moment). We definitely broke through the clutter to reach our voters. We ran a multi-dimensional campaign that was long on organization and strategy. I can tell you that the last few years of hanging around the assorted political junkies and professionals that comprise RedState’s contributor roster, gave us insights that paid off big-time.

I’d like to say that tomorrow the voters of western Queens will decide whether we made the sale. That’s where the picture gets complicated.

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There are many good reasons to have a deep conversation about how health insurance works in this country, because there is a lot of things wrong with it. What we’re getting from Obama and Congress, however, is a PR campaign designed to distract us from the fact that they would like to change not health insurance, but practically everything about health care itself.

Reports have it that Obama’s pollsters recently suggested that the President try to make the private insurance industry the villains of the piece. This has several virtues: it’s always rhetorically good to have a single, easily-demonized bad guy; and if it works, it conveniently will distract everyone from the fact that the true objective is far deeper than simply to make insurance cheaper for those who currently have none.

(What is the true objective? By God in Heaven, I wish I knew so we could debate it openly. But the true objectives of health reform are one thing Obama and Congress are keeping a deep dark secret. I can read legalese, but I can’t predict the unintended consequences of far-reaching thousand-page laws any more than Nancy Pelosi can.)

So the rhetorical device being used against those of us who would rather know what we’re getting into, as opposed to hoping blithely that the reforms will do what Obama promises, is this: the health insurance market needs some new competition.

In a truly remarkable moment, HHS Secretary Sebelius let the cat out of the bag this morning when she said that, although a public option isn’t a strict requirement, the President is committed to some structure that will, through the miracle of competition, induce private insurance companies to “do the right thing.”

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Here’s Lanny Davis, the former Clinton team member and all-around Democratic good guy, on the subject of the “public option” crowding out private competition, and becoming a stalking horse for a single-payer system:

“I favor a public option – but the White House needs to explain better why, if public option is heavily subsidized by tax dollars, it won’t always have substantial competitive advantage over any private insurers, even those with very modest profit margins, and thus, will not result in a total federal government take-over — in effect, socialized medicine as in Canada, U.S., and the U.K.”

If I’m reading Davis correctly, he thinks there’s no problem with a public option that better communication (aka lying) can’t solve. That’s unless he honest-to-goodness believes that a public option won’t lead eventually to a single-payer system.

There’s a really stupid-simple question I have to ask. If there’s room in the market for another health-insurance vendor, then why haven’t capitalists and entrepreneurs stood up one or more new ones? By definition, that statement means that money is being left on the table. Nothing, but nothing, would prevent legitimate business people from rushing to fill that void. It’s like catnip.

Since it’s not happening, then obviously there’s no opportunity to do anything here, unless you have advantages that simply can’t be matched by the private sector.

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This morning, the Commerce Department published the much-awaited first look at US second-quarter GDP. You’re going to hear in the news that the recession is officially over, because the economy is reported to have shrunk in Q2 at a 1.0 percent annual rate. This compares with 6.4% in the first quarter. The report also includes a large downward revision to the Q1 number, as well as downgrades to consumer spending statistics for 2008.

Exactly what does it mean to say that the economy shrank by 1.0 percent in Q2? It’s a comparison of the value of the nation’s economic output between Q1 and Q2, expressed as an annualized percentage. The economy got smaller in Q2 compared to Q1, but at a much slower rate than it had declined in Q1 from Q4 ’08. There’s a limit to how far you can keep declining. The economy is no longer in free-fall.

Financial markets are taking this report as borderline bad news, however. The thing that jumps out of the report is that all the improvement in the economy (which is to say, the decline in the rate of decline) is due to government spending at all levels. Consumers aren’t spending more. Rather, they’re saving more.

So are we creating the conditions for a return to private-sector growth? The answer isn’t necessarily no. I think we’re creating the conditions to broadly transition the economy from a consumer-directed one to a government-directed one. The vitality and dynamism of such an economy will be far less than what Americans are used to, but that doesn’t mean we won’t have growth.

I hope you work for a defense contractor or government-funded healthcare provider, though. (Government spending on defense rose over 10% in Q2.) It’s also going to be very, very good to work for a government, since civil servants will get (and keep) gold-plated benefits, while private employees will get more uncertainty.

I’ve been saying this for five months now, in this space and elsewhere: this outcome perfectly matches the on-the-ground trends I’ve been seeing in my own businesses this year. Defense companies and health companies are spending. The bailed-out financial companies are spending. The governments are spending.

Everyone else is cutting.