More Of The Same

February 13, 2013

Opinion

The President's message last night was, as expected, simply more of the same: More spending and more taxes.

It was expected because the presumptive opinion in America (as defined by politicians, economists and the media) is that the government will find a way to deal with our problems -whatever they are- and that we do not need to worry.

This view, made popular during FDR's reign and reinforced and expanded since by both political parties, believe that the government can and should inject itself into the economy because the economy needs to be managed. That market forces cannot do the job.

The president said we need to do more. I interpret that to mean we need to take more money from the people who earned it, the producers, because the 50-60+% percent being taken now isn't enough or even fair. And besides, the government knows how to spend this money better than the people who earned it.

You may think differently but right now we live, work and invest in this Keynesian world; therefore, going forward we can expect the following:

1. Governments (all levels) will continue to spend excessively and borrow or print more money because there is no incentive to stop (see ZIRP below.) When the States get into trouble, they believe the Federal Government will bail them out.

2. The Federal Reserve will continue their Zero Interest Rate Program (ZIRP) for as long as they can to help banks (it's their job); and to keep interest rates low to "help" people buy/refinance their homes. And maybe one other thing, the Federal Government can't afford to have rates rise because every 1% rise in interest rates will cost the government over $150 billion per year in additional interest.

3. Currently, the Federal Government is running close to $100 billion per month in deficit spending and the Federal Reserve is printing and pumping in another $105 billion per month. The results so far are not too good however. Preliminary Fourth Quarter GDP decreased at an annual rate of -0.1%. But, it's only been four years.

4. Normally, increasing money supply causes inflation. However, even with the trillions of dollars injected into the economy, we do not see inflation as measured by the Consumer Price Index (CPI.) One reason is of course the way CPI is calculated. The other is that the money being injected by the Fed is going directly into the banks. The banks are not lending the money because they can make more money by buying assets (stocks, bonds, currencies, foreign investments, etc.)  

4. Therefore, we have a kind of stealth inflation because real inflation is not visible in the usual places. However, inflation is visible in asset prices (stocks, bonds, metals, etc.) because that is where the banks are "investing" their free or almost free money from the Fed.

5. This kind of malinvestments will eventually cause "cost-push inflation" (increased costs of materials including energy and labor will force prices up and thereby reduce supply.) Reduced supply then causes prices to increase.

6. Today, the government cannot raise rates to combat rising prices (remember Paul Volker) because U.S. debt is too large and interest on the debt would become unaffordable. Nominal rates on the 10-year Treasury of 5% would increase interest payments close to the size of the Defense budget.

So what do we know after the President's speech? The government is going to keep pumping money into the economy raising nominal GDP, asset prices (including the markets) and inflation. We will need to continue investing like a Keynesian whether you believe in this dogma or not, but keep an eye out for the black swan.

Election Result: We Want To Maintain The Status Quo, But..

November 6, 2012

After spending $6 billion in platitudes and demagoguery -without addressing a single, important issue - the result of the election was simply to maintain the Status Quo: Democratic President and Senate and Republican House. But now, the President and Congress have to deal with the real issues: spending, revenues and debt.

Mandatory spending (mostly Social Security, Medicare, Medicaid) plus the interest on our debt amount to about $2.5 trillion per year. These are policy programs so the payments are not voted on by Congress, they are made automatically every month just like telling your bank to automatically pay these bills from you checking account each month.

This $2.5 trillion yearly total is paid from federal revenues (mostly taxes) which amount to about $2.5 trillion per year (about 18% of GDP.) Great, except there are 10,000 baby boomers being added to this payroll each month plus the costs of inflation.

But, we still have about $1.2 trillion per year of Discretionary Spending (for things like Defense, Education, Homeland Security, etc.) Since we are out of money, we borrow these funds so we really spend about $3.6 trillion per year, borrow $1.2 trillion and add it to the debt each year.

So, mathematically, how do we solve this problem?

In recent polls, 80% of people want the government to cut spending; 80% of people do not want cuts in mandatory spending; and 66% of people do not want tax increases. Go figure. But we must to do something before our credit card is maxed out.

So after blowing $6 billion on hopium and personal attacks, we are back to raising the debt ceiling and blaming the "other side" for all our problems: The Status Quo.

The Real Debate

October 16, 2012
After watching the debate last night, I had a bunch of questions I thought were important but that were never asked. Here are three of them:

1. Why has the economy (GDP) been trending down for the past two years and the stock market moving up?
The answer of course in that the government has been pumping money into the banks (TARP, QE1, QE2, Twist Program and now QE3 with no limit as to the amount of money they will print.) This money goes to the banks and then the banks use this money to invest in the market (stocks, bonds, foreign investments, etc.). This 65% increase in “green paper” or money has driven the stock market up about 71% from the bottom in February 2009. This is illusionary wealth also called a bubble and like all bubbles, it will pop.

And just to make sure this money will go into assets that raise the value of the market (or what government economist’s call the “wealth effect”) which is suppose to make us run out and spend money; the Federal Reserve has instituted a Zero Interest Rate Policy (ZIRP) to make sure no one saves and is forced to go into the market to earn any interest.

2. How can the government continue to keep spending and driving up debt when mandatory spending (Social Security, Medicare, Medicaid, Other Mandatory spending -like VA benefits, welfare, etc. – and the interest on the debt equal the entire revenue?

In 2012, the government spent $2.5 trillion on mandatory items and interest and received $2.5 trillion in revenues (taxes, tariffs etc.).

That leaves Zero money left for all other discretionary spending ($628t) and defense ($680t). This is more than a trillion dollars a year which means we will likely not even have enough revenues to pay for mandatory spending next year unless the economy picks up.

Follow up question:

So to get to a balanced budget, are you going to cut discretionary spending (education, homeland security, perks for your constituents, etc.) or Defense Spending (even though defense industries are scattered in every State to ensure Congressional votes)?

You know the answer. No and No.

3. Economic data has been very weak and deteriorating; yet this past month, two unbelievable things have happened to make me confused:

A. The Federal Reserve Chairman has been saying for some time that the economy has been slowly improving; and that based on the data, the Federal Reserve stands ready to assist (meaning QE3) if the data shows the economy is slowing further. Yet, two weeks after saying this for the umpteenth time, the Fed surprises the market with potentially the biggest injection of money ever! What about the data? I thought we were improving?

B. The data. This month the data, in contradiction to the Fed action, has been unbelievable: unemployment has dropped, retail sales have jumped significantly higher, housing starts have jumped significantly higher, etc.

We know you have “economic models” to predict the numbers, but the data does not fit the description of the economy provided by the Federal Reserve Chairman prior to injecting money into the banks (QE3). Does this mean the economy is getting worse and the models will reflect the real economy in a month or two or have the models just gone wacky?

Well, I know I’m over the time limit and it’s my opponents turn to talk so I’ll stop.

We Again Kicked the Can, But the Road is Now Going Down Hill

The “Debt Deal” will likely pass the House and Senate today. It does not reduce the budget or spending very much. Here’s why. The base line or assumption is that the budget will grow about 7% every year (that means a 7% increase is priced in.) So, if the 2011 budget is 3.6 trillion, next year the budget will start out at $3.6 plus $250 billion or $3.85 trillion (assuming no more wars, etc.)

Therefore, in 2013 when the debt ceiling is reached again, the deficit will be $16.6 trillion rather than the $14.2 we have today; and the budget for 2014 will start at $4.1 trillion. Unless we have a national discussion about why we are spending this much money and reach a national consensus, we will continue to let politicians keep spending and monetizing our debt. If you create enough inflation to make previous debts meaningless, is that a default?

At the same time, the global economy, at a minimum, is contracting or slowing down. Therefore, the euphoria that passing the debt ceiling brings will be very short lived. We will have to immediately focus on the economy again and jobs. And there seems to be only one thing the government knows how to do, spend money and pass regulations. Also, it is only 15 months until election so stimulus and QE3 will have to be set up and implemented quickly.

Unfortunately, what we really need is for the government to get out of the way.

What Slow Patch? Aren’t We Still In A Recession?

With the bad economic numbers we have been getting lately (employment, housing, manufacturing, etc.), the economy appears to be turning down again.

Consensus among mainstream economists is that the “recovery” is only entering a “slow patch” as we transition from a government funded recovery back to a private sector funded economy. The reason for this “slow patch” is that stimulus programs are running out of money and the Fed’s QE2 program is ending in June. Therefore, we have to be patient as the “real” economy continues to grow.

The real question is “Aren’t we still in a recession? We have spent trillions of dollars and all we have to show for it is debt. Now, we are going to have to go through a “slow down?”

Let’s face reality. Either the government gets out of the way and lets the economy reach equilibrium, as painful as that would be; or we borrow and spend more money to keep our economy growing at 1% (stagflation level). My guess is that the government will spend more without cutting or saying they will start to cut in 2014 (when they are all retired.)

Hit reply and tell me what you think:
Will they cut spending?
Will they spend even more?

There is one other thing they could try. They could stop looking short-term (definition: days to next election) or they could look at the cause of the recession (government intervention, spending on the flavor of the month, the tax code, trillions of unnecessary regulations, manipulation of interest rates, etc., etc.) That is what caused the bubble in the first place. Now, we are in the process of doing it over again. It’s time to re-think our priorities first, then budget levels.

We’ll Keep Printing, Will They Keep Buying?

I have been concerned about all the money being pumped into the economy and the inevitable inflation that will result. However, the symptoms of inflation (Consumer Price Indexes or CPI) have been mild (by model definition) or perhaps even disappointing to Fed Chairman Bernanke. He wants to re-inflation the economy to help turn around housing and employment/wages. Why he wants to prolong this recession by preventing prices to reach equilibrium is an open question.

We do know is that all of this money is holding up or levitating GDP. And we know that to keep GDP going, we need to keep printing money. We can do it because we are a sovereign country and can print as much money as we want (not without consequences however.) We are currently borrowing 43 cents out of every deficit dollar we spend. The problem is that the Federal Reserve is buying about 40 percent of these dollars followed by China and Japan. Will these buyers continue to buy our Treasuries?

I am not sure. One reason is that the Federal Reserve’s Quantitative Easing (QE2) policy of buying $600 billion in bonds will end in June. Who is going to pick up that 40 percent in July? I have been saying that the Fed will probably initiate QE3 because they have to keep it going. The next election is not that far off.

What does appear more certain is that we will keep spending and printing. The rumor yesterday was that Congress has reached a compromise to cut $33 billion (less than 1%) of the budget. If they (both parties) can’t cut even 1%, how are they ever going to extricate themselves from micro-managing our mixed (or Statist) economy.

Will The Government Continue To Pump Money Into The Economy?

I spent most of last week in Auburn, Alabama at the Austrian Scholars Conference where I listened to 40 presentations on various aspects of the economy from Austrian (or Capitalist) economists. It was excellent. I thought I would share one of my "take home" ideas on government spending (fiscal and monetary).

I think the government will continue to pump money into the economy (financial system) to keep it afloat. Most of the "growth" in GDP growth is from the government and the amount of GDP growth per dollar spent is declining. I am assuming that if the economy were really turning around based on private investment and spending, the government would stop injecting borrowed money into the system.

There is a lot of talk about the election of "Tea Party" legislators and their willingness to reduce spending and begin to get government budget under control. I don't think that will happen. The Republicans are proposing a $60 billion reduction in spending (1.6%) and the Democrats have countered with $6 billion in cuts.

Neither amount is significant and the focus is on cutting a few dollars out of the budget. However, the focus should be on the cause of overspending not just the symptoms of it. Why are we overspending? Why are we willing to borrow 43 cents of every dollar we spend? For what purpose? For whose benefit?

For example: Why are we spending $800 billion a year on "defense" which is 50% of what the world spends on defense? Why have we politicized science: one administration spends billions on programs to get us to Mars (Bush) and the next administration (Obama) shuts down those programs (wasting that money, education, etc.) and then redirects billions on satellites to monitor global warming instead? Why do we have a government (both administrations) that spends hundreds of billions to bail out banks with taxpayer money when these banks could have saved themselves? These are the kinds of questions we need answered before we are going to get serious about priorities and cost reductions.

Therefore, I expect to see one or more of the following: Quantitative Easing III (the Fed printing more money) and or the Fed keeping interest rates low for a much longer time (well into 2012) and/or more "stimulus" programs (we haven't solved our problems yet.) This of course has implications for both business and investment planning.

More Money Or Less Money In 2011, That's The Key

Will 2011 be the year the US creates massive amounts of new money to "solve" our problems and temporarily levitate our GDP? Or the year of austerity and GDP contraction? It seems to me the key to 2011 is more money or less money.

Economists, politicians and pundits have developed lists and lists of problems, strategies, and opportunities we face in the coming year; and there are many. With a few exceptions, they all seem to boil down to money.

Will the government decide that it has to create or print more money, even though we know we have to borrow it and worry about the burdensome debt later. By the way, the government just added about a trillion dollars in additional debt with the "tax compromise" bill they passes just before Christmas. If we print more money, the argument goes, we could:

1.Get the debt ceiling limit of $14 trillion raised before we reach it in March
2.Pay for the estimated budget deficit of $1.5 to $2.0 trillion again this year
3.Transfer money to the states so they could meet their out-of-control budgets. They will be about $200-400 billion dollars short this year and next.
4.Try to get our arms around the housing problem. The billions of dollars spent to date haven't solved the problem and now we could be looking at a double dip in housing.
5.The additional money banks will need if housing prices continue to decline causing millions more defaults and foreclosures
6.Add more government spending (stimulus) to fill the spending gap caused by consumers lack of spending.

Or will the government decide to cut spending and save the country from default or hyperinflation. Contraction of the money supply however, will cause GDP (the mathematical model we use to represent the economy) to decline. And yes, money contraction is deflation. That's how we get to equilibrium so we can get this recession over.

Within the first three months of this new congress we should know which direction our government central planners intend to go. Make plans. Be ready.