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Will Laffer’s ‘Train Wreck’ Scenario Come to Pass?

The proximate cause of yesterday’s stock market sell-off was the growing fear of European government defaults and the future of the euro currency itself.

These are legitimate fears.

But I wouldn’t make too much of this.

Greece, Portugal, and Spain are all lovely places, but how important are they really?

The European Union must stand behind those governments. And just as important, the EU and the European Central Bank must stand behind the euro currency, which has plunged from 1.50 to 1.37 and is still falling. I do believe Europe will act responsibly. But if the EU and the IMF make these southern European countries raise taxes to balance their budgets, it will spell euro disaster.

But then again, is it so farfetched to say that Team Obama and the Democratic Congress aren’t following the same big spend-and-borrow policies as Europe? (Incidentally, Moody’s is saying that U.S. government debt eventually could be downgraded.) And a whole spate of tax-hike proposals, beginning with the bank tax, and continuing on down to multi-national corporate tax hikes and a failure to extend tax cuts on capital gains and the incomes of successful earners, is penalizing exactly the people who were most likely to invest in economic growth and recovery.

All of this is an ongoing cause of the 700-point stock market correction.

I don’t want to get too bearish on this year’s economy. One of America’s great businessmen, Cisco’s John Chambers , is very optimistic. Profits and productivity are soaring. Business capital investment is rapidly recovering. Chain-store sales picked up more than 3 percent over a year ago.

These are all very positive signs.

Of course, jobs are still the big problem. This morning’s report did not show much improvement in unemployment. Businesses, large and small, are still afraid to hire workers with various tax-cost-increase threats coming out of Washington on an almost daily basis.

So, here’s the question: Is there a train wreck coming in 2011, as my friend Art Laffer believes? He’s right about higher taxes and tighter money next year. This year, 2010, could be strong, but it’s next year that he believes could be very weak.

The forward-looking stock market may already be looking toward next year’s problems, unless Washington comes to its senses and calls off the war against capital and business. These remain the real storm clouds on the horizon.

So I’ll stay with my view that 2010 is going to be a strong year.

And I’m going to stay optimistic about the political revolution, led by Sen. Scott Brown and many others, which could change the balance of power in Washington such that all these tax-hike threats never come to pass. That’s my optimistic play.

But I’ll tell you what. Even though the U.S. economy is recovering this year, it’s still a very politically driven stock market right now, based on threatening policies from Washington.

Unfortunately, we are going to have to work through this. The level of uncertainty out there is unusually high.

And until that uncertainty passes, stocks may be in for a continued correction.

On CNBC.com now:

Questions? Comments, send your emails to: lkudlow@kudlow.com