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.

The Lack Of Consumer Spending Is The Problem, Right?

Everyone knows that what is causing the recession is the “gap” in consumer spending, Right? That is the explanation according to Keynesian economics and that’s what we have been told. So after spending trillions of dollars trying to fill the consumer spending “gap” and creating $15 trillion in debt; we have been told (Paul Krugman, et.al.) that we just didn’t spend enough.

Great, so we are now about to spend some more on: 1, a new “jobs” bill that will do nothing but add to the debt and accomplish nothing long-term and 2, a new Quantitative Easing Program ( QE3 or money printing) to help the banks and hurt savers.

Printing money does levitate the market, especially when the new printed money goes to banks who can then invest it in the capital markets and in higher paying foreign investments. BUT, consumer spending is not our problem. Here are some numbers from the Bureau of Labor Statistics (dollars in trillions) that prove the point.

Year....................2006 2007 2008 2009 2010
Government
Expenditures...........$4.14 $4.43 $4.73 $4.99 $5.26

Personal
Consumption............$9.52 $10.00 $9.74 $10.34 $10.45

Private Fixed
Investment
(Business
Spending)..............$2.26 $2.26 $2.12 $1.70 $1.72

This is telling us that the real problem is Business Investment. It is down by $539 billion or 23% from the peak in 2007; and running at about 76% of the 2006 level.

Isn’t this the real question: Why are businesses unwilling to invest and grow? Or is all the investment overseas where the business climate is more favorable?

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.

Moody's Has It Absolutely Wrong

July 18, 2011

There will be a market reaction to passing or not passing the debt limit. But it is time to start thinking about this problem as adults rather than as political party advocates. Moody’s comments the past few days are a prime example.

Moody’s, the credit agency has stated they are likely to downgrade America’s AAA credit rating if the debt limit is not raised.

Today, Moody’s stated that America should get rid of the debt limit ceiling altogether because it gives them a reason to downgrade our credit rating. This is not only illogical; it’s symptomatic of the way politicians, economists and pundits think. They almost always attack the symptom rather than the cause.

What Moody’s should be saying is that the Congress needs to pass a law that forces politicians to reduce the debit ceiling by some percent every year until our budget is balanced. Our problem is not the current debt ceiling. Our problem is that our budget is not balanced and on an unsustainable path upward.

There are two major reasons we spend too much.

One, the party out of office attacks the party in office for spending too much and the party in power defends the spending. When election results change, so do the positions of the parties. Congress has raised the debt ceiling 140 times since it was enacted in 1917.

By the way, the debt ceiling was created by President Wilson in order to pacify the opposition that he would not spend too much on WWI.

Two, we refuse to debate the cause of our problems. We only debate the amount of money we will spend on the symptom. For example:
1.Why does America with 5% of the world’s population spend about as much as the rest of the world does on defense? Is America responsible for most of the world? If it’s to protect democracy, why doesn’t Switzerland spend more?
2.Why hasn’t poverty been eliminated after trillions have been spent on the poor? Is poverty simply a percent of the population? Are the government and the population an enabler? Is our education system failing us? Etc. etc.
3.Why do we worry about the consumer price index (CPI)? It is only a symptom. Inflation is not a manipulated, mathematical index; it’s the increase in money supply. Should we be increasing the money supply?

I could give you a thousand examples but I think you got the idea. We need to change the way we think. Once we identify the real cause of the problem, we should be able to get consensus on how much to spend solving the problem.

By the way, America has defaulted on our debt five times starting in 1776. Also, the Federal Reserve can buy bonds to fund the government forever and never have to default on the “Public” debt (public debt is what we are talking about.)

Update On Scenario One

This remains the most probable scenario at this time (of my four total scenarios.) However, other scenarios are possible depending on what the government and central banks do (more money creation or money contraction) and what banks do (possible trillions in credit to consumers which is money creation) and how individuals react (credit defaults, savings, leverage, etc.)

1. March 2010 (massive increases in money supply which artificially and temporarily increases GDP but results in malinvestments or bubbles)

a. Interest rate reduction
b. Stimulus Programs
c. Mark-to –Market rules revised (allowing banks to increase value of mortgage bonds)
d. Central Bank buys “toxic bonds” from banks (QE1) increasing ”excess reserves” at banks to $1.1 trillion from $4 billion.
e. November 2010, QE2 begins ($600 billion more pumped into banks but most of it goes into European banks)
f. Money supply increases at double digit rates for 28 of last 29 months

2. May 2011

a. Stimulus ending in June
b. QE2 ending in June (both a and b will contract money supply which will reduce GDP)
c. Debt ceiling “argument” (raise limit by $2-3 trillion or austerity) deadline by August 2

3. Labor Day (+/-) or possibly sooner depending on our central planners (government and the Central Bank

a. My guess, debt limit increased with promise to cut spending starting in 2013 (after next elections) Raising the debt limit is priced into the markets now.
b. As economy drifts lower, pressure for government to “do something.” Therefore, I expect a new stimulus program (significant tax cuts because Republicans will have to vote for them and Democrats will get their stimulus because we will borrow the money displaced by the tax cuts)
c.New QE3 program (large) so central bank can continue to buy bonds and keep interest rates low (for housing, employment, etc.) This may be called something else so it can be framed differently for public consumption.
d.Timing of new stimulus for 2012 elections will become important to allow for lag time and momentum prior to elections.

4. Top of Bubble (then significant recession)

5. S&P500 down to about 650-600

Of Course There Is Inflation. Why Haven’t We Seen It?

Every month we get an inflation report. We know gas prices have almost doubled in the past two years and food prices have risen significantly, but according to Fed Chairman Bernanke, we are not seeing any significant inflation. What gives? Why is the government reporting such low inflation numbers?

One reason is the way inflation numbers are reported and the way information is played out in the media. For example, inflation for January was +0.4% and +1.6% year-over-year. First of all, it was just “slightly” higher than expected. OK, it doesn’t sound that bad I guess. But what if it would be reported that + 0.4% annualized is +4.8%. Or that over the past year, inflation has risen steadily from a year ago. Or that inflation has risen 26.5 % since 2000 or 164.1% since 1980. In other words, there is not much context to the report and therefore, it is minimized.

Another reason is that the media is obsessed with speed rather than content so rather than a discussion about inflation or its content, they will simply move on to new information tomorrow. Besides, they think everyone is bored any way once they have heard the number.

Another reason is the way inflation moves through the economy. In the early stages of inflation, it generally rises slowly because the numbers are small in the beginning and people do not think that inflation is here to stay so why worry. If it persists, people begin to change their minds. Once they think inflation is here and growing, people begin to react and it begins to rise more rapidly. Since it’s a compounded percent, the longer it goes, the faster it rises.

We have an unusual situation also, The money supply has been increased dramatically (the cause of inflation) but many people including many economists and the Federal Reserve have been or are worried about deflation (definition is money supply contracting) because of lower sales, lower prices in some cases and consumers not spending as they did in 2007. Never mind that consumers haven’t de-leveraged themselves yet from historic levels in 2007.)

Also, the huge increase in money supply has gone to the banks for the most part. They do not need borrowers to make money. They have been putting the money into assets (bonds, stocks, etc.) and investing overseas. We do not count a rising stock market or heavy buying of bonds (which drives interest rates down) as inflation. Yet that is what is happening. So it appears that we are creating an asset bubble at this time, just different than the tech bubble or housing bubble.

We are also exporting much of our inflation to the Chinese: exchanging our higher cost of production for their low cost imports.

One last reason is the huge Federal debt. Imagine what “investments” could be made by the private sector if we didn’t have to pay hundreds of billions of dollars in interest to foreign countries.

That’s some of the reasons we are not “seeing” inflation. We are not looking for it. But it is here and it will be rising throughout the year.

Why Would the Market Shrug Off a Bad Jobs Report?

One reason could be statistics. There was an alarming plunge in the number of people in the labor market. People drop out for many reasons including going back to school, retired, have given up looking for a job, etc. So, in spite of only creating a net of 35,000 jobs last month, the unemployment rate dropped from 9.4 percent to 9.0 percent. That number sure sounds better.

Another reason might be conflicting surveys. The 35,000 jobs created is from the Payroll Survey which is a survey sent to businesses. This survey is where the government gets the number of jobs created which is reported each month. By the way, the margin of error here is 100,000 jobs. The other survey is the household survey which is a telephone survey. This survey is used to determine the percent of people employed/unemployed. This survey showed a jump in employment of 598,000 jobs which measured against a reduced labor force number resulted in a reduction in unemployment to 9.0 percent.

There are a lot of other statistics that could be analyzed, but the most compelling for me is the amount of new money being pumped into the economy by the Federal Reserve: over $100 billion per month and yet GDP is only rising (or “growing”) by about $40 billion per month. Where this money is going will be the subject of another post. But, this money is levitating the economy and Mr. Bernanke said in testimony last week that until the jobs situation turns around (not sure of his definition but it’s not 35,000 jobs per month) the Fed is going to continue to pump money into the economy. If so, GDP rises which filters into the capital markets. So, what’s a bad number or two?

Consumer Spending Jumps, But Where Did They Get The Money?

Economists recently increased their estimates for GDP growth in 2011 after retail sales jumped in December. Did wages jump, no. Did employment jump, no. So where did these consumers get the money?

I don’t think consumers got it from paying off old debts. The consumer debt to disposable income ratio has dropped from 15 percent to 13.96 percent over the past three years (but mostly due to reduced interest rates). The amount of debt remains very high. It has dropped 3.5% over the last two years, but it has only dropped from $13.92 trillion to $13.42 trillion (and much less home equity to offset that debt.)

So it’s pretty obvious consumers received this new money from the government. Maybe the new near $900 billion dollar, December stimulus program (tax cuts, payroll tax deduction, extended unemployment benefits, accelerated depreciation, etc.). Or the $100 billion dollar a month deficit we are financing. Or the monthly $75 billion dollar Quantitative Easing (economist talk for printing money) program under way by the Federal Reserve.

Much of this money will go to either propping up GDP or increasing GDP. Either way, it’s just like the stimulus program, it’s temporary. That is unless we get new, temporary, “investments” (political talk for spending) in the months ahead.

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.

If we could just spend more on interest, we could really stimulate GDP growth

This may not sound right, but give me a second and I’ll show you that this statement is true.

The economy, as defined by most politicians and economists, is a mathematical model called Gross Domestic Product or GDP. This model is based on consumption (spending by consumers, businesses and the government.) rather than wealth building or production. So every dollar spent is a dollar of GDP and every new dollar spent is GDP growth.

Now, if you are in Congress or the President, you could catch on to this real fast. The more you spend, the more GDP goes up and the better your chances for reelection. But it gets even better.

But, we have one speed bump to get over first. To spend a dollar you have to produce a dollar. But the government doesn’t produce anything so it has no money to spend. No problem, it just has to get its dollars from somewhere else.

The government has to take a dollar from producers in order to spend a dollar; or it has to borrow the money with interest from someone else. It doesn’t matter where the dollar came from in the GDP model because every additional dollar the government spends is counted as an increase in economic growth (GDP.)

Now, if the government takes a dollar in taxes from a producer to spend. You could argue that the net is the same; you subtract a dollar from the economy in taxes and then spend that dollar. This could hurt down the road when you have to increase taxes to pay for the dollars you are spending now; but who cares. Many think they will be out of office by then.

You would think tax payers would catch on to this, but remember you elected them because they were clever and great communicators. So they just change the meaning of the word spending to investment and everyone is happy. Long-term you try to convince tax payers that you are only doing this because the government can spend dollars more wisely than the producer or because the government can buy something the producer cannot.

Wait. I’m not done. Here is the BINGO. You borrow lots of the money because if you pay-as-you-go, tax payers could catch on. And you get to pay huge interest payments on the borrowed money—you got it. Every new dollar paid is an increase in GDP.

Now, think of the GDP growth we are going to get when our deficits go up by 10 trillion or more over the next few years. PLUS, if interest rates rise significantly because of all the debt, BINGO –even more GDP growth.

If you think this is a sane approach to our economy, do nothing. If not, support politicians who are sane.