Friday, December 21, 2007

Energetic Pork

The WSJ has an editorial on the recently signed Energy Bill:

The White House is boasting that the energy bill President Bush signed on Wednesday is actually less ambitious than the agenda proposed in his State of the Union address earlier this year. That's praising with faint damns.

As recently as last week, it seemed the final draft might have raised taxes on the oil and gas industries by some $21 billion to fund subsidies for wind and solar projects. Another provision required that utilities produce 15% of their electricity from "renewable" sources, regardless of supply; currently they are a mere 3%. All that was relegated to a Congressional dumpster, thanks to veto threats from the White House.

The pity is that the entire bill didn't go to the same place. The Administration's environmental views are supposedly paleolithic, but it's long been obvious that Mr. Bush has also bought into some of the Beltway's most useless energy superstitions. This political panic is bipartisan.


What a collosal waste of taxpayer's money. Ethanol features prominently in the bill and there are also subsidies for bio diesel. The most invasive part of the bill though is the mandate that incandescent light bulbs be phased out by 2012 in favor of compact flourescent bulbs. My wife is not going to be happy. Like many others, she hates the light from flourescent bulbs. Why should a bunch of politicians tell me what kind of light bulb I can use?

Fed Auction Part II

Dec. 21 (Bloomberg) -- The Federal Reserve loaned $20 billion in 35-day funds at a rate of 4.67 percent in the second of four special auctions planned by the central bank to boost the amount of cash in the banking system.

The rate was higher than the 4.65 percent received at the initial auction two days ago. Financial institutions submitted $57.6644 billion in bids, resulting in a bid-to-cover ratio of 2.88, lower than the prior auction. There were 73 bidders, compared with 93 banks and securities firms earlier, the central bank said in a statement today.


There is still plenty of demand for these loans, but not as much as the first one. What does that mean? Well, the rate is not much less than the official discount rate so maybe the banks don't need the money that badly.

Singapore Sling

Merrill Lynch is the latest US financial institution to go hat in hand to a state investment agency:

HONG KONG (MarketWatch) -- Merrill Lynch & Co is in advanced talks to receive a $5 billion cash infusion from Singapore's state investment company Temasek Holdings Ltd., becoming the latest among a number of blue chip Wall Street and European financial institutions to receive funding from Asian or Middle Eastern government funds in the wake of the ongoing turmoil in structured credit markets, according to a media report Friday.


I see this as further confirmation that the bottom is not yet in for the financials. I don't see government bureaucrats as savvy investors.

Still Shopping

The death of the US consumer has been forecast many times and the turmoil in the mortgage market gave the bears another chance to trot out this meme. If Americans can't refinance their mortgages, where oh where will they get the money to keep spending?

Dec. 21 (Bloomberg) -- Consumer spending in the U.S. rose in November by the most in more than two years as incomes grew and shoppers took advantage of early holiday discounts.

A bigger-than-forecast 1.1 percent increase in purchases followed a revised 0.4 percent gain in October that was more than previously estimated, the Commerce Department said today in Washington. The Federal Reserve's preferred measure of inflation accelerated, the report showed.

More jobs and higher salaries may avert a collapse in spending, which accounts for more than two-thirds of the economy, as home values fall and fuel costs rise. The jump in sales last month reduces the odds the economy will contract this quarter, even as retail surveys suggest shopping has cooled in December, economists said.


This isn't all good news; incomes weren't up as much as spending so Americans are still borrowing from somewhere as the savings rate dipped into negative territory again. That certainly doesn't bode well for the long term health of the US economy. At some point, we will have to save and invest again; we can't depend on the rest of the world indefinitely.

Thursday, December 20, 2007

Own to Rent: Not a Good Idea

Doug Wilson has an article at TechCentralStation about a proposal to allow foreclosed homeowners to remain in their homes by paying a fair market rent to their former creditors:

But, ironically, Dean Baker, an economist at the liberal Washington-based Center for Economic and Policy Research, has proposed a cheap, ingenious fix that would alter both borrowers and lenders' incentives in ways that let markets manage what the Bush Administration attempted to orchestrate in bank boardrooms. He would simply give foreclosed homeowners the right to remain in the houses by paying the fair-market rent (as determined by court-appointed appraisers) to their former creditors.


This "own-to-rent" approach would spare the most sympathetic victims of the mortgage bloodbath without giving them a free ride - along with paying rent, the reality that they had defaulted on mortgages would surely damage their credit. What's more, it would keep many foreclosed houses off the market, reducing the glut that will likely depress housing prices for years to come


There are at least two problems with this proposal:

1. Court appointed appraisors - Would these be the same appraisors who until recently were perfectly willing to value homes at prices that made no economic sense?
2. Why should banks, mortgage companies and mortgage investors be forced to become landlords?

I guess I shouldn't be surprised that Doug Wilson is identified as a consultant to the home-building industry. Maybe he has a vested interest in keeping "many foreclosed houses off the market"?

Dollar Rising from the Dead

FRANKFURT, Germany (AP) -- The dollar continued to make gains against the pound and euro Thursday amid mixed data on the U.S. economy.
The 13-nation euro bought $1.4335 in afternoon European trading, down from $1.4381 in New York late Wednesday. The pound dropped to $1.9820 from $1.9966.


The sentiment on the dollar had become so negative that this was inevitable. As I wrote last month, when supermodels are aware of the trend in the dollar, the trend is too well known to be exploited.

Many have been calling for the dollar to fall further as interest rates in the US fall while the ECB holds them steady. I have never understood those who cling to this belief; currency movement are more about economic growth than interest rate differentials. The European economy in a number of ways is in worse shape than the US and with the ECB focusing so much on inflation rather than growth, investors are voting with their assets and moving to the area of greater potential growth. I don't think this will last long term though; tax rates are falling in Euro land and are likely to rise in the US over the next few years. A more favorable investment climate in Europe will likely benefit the Euro.

Job Market Softening

Jobless claims have been trending higher over the last couple of months and are approaching what I consider a danger zone:

WASHINGTON (AP) -- More people signed up for unemployment benefits last week, suggesting that the job market is softening as the economy loses speed.
The Labor Department reported Thursday that new applications filed for jobless benefits rose by a seasonally adjusted 12,000 to 346,000. It was a larger increase than economists were expecting. They were forecasting claims to rise to 335,000 last week.


Weekly jobless claims in excess of 350,000 is about the point where things get dicey for the economy. The unemployment rate will likely start to rise soon if this is not reversed.

Ben Stein on the Credit Crunch

Ben Stein has written an article on the credit crunch with good advice for investors:

Still, the lessons for us are keen and cut like a knife. But be brave -- these periods of crisis are inevitably the time to buy, even if you have to wait years for the crisis to sort itself out. It takes guts and counterintuitive thinking, and if you don't have the stomach to do it, no one will blame you.

If you do jump into the pool, be sure to diversify, give yourself guaranteed income from variable annuities and annuities, and stick with proven entities like very largely varied index funds at home and abroad. As you all know, I particularly love the emerging market funds and ETFs for the long haul.


Other parts of the article explain the credit crunch pretty well and as usual Stein is not happy with Wall Street:

No one, and I mean no one, knows how large the losses have been as the buyers of the mortgage pools have seen their investment dry up and blow away. By my rough calculation, with help from the president's Council of Economic Advisers, about 6 trillion dollars of new mortgages were issued between 2005 and mid-2007. Of this, about 20 percent might have been subprime. That makes $1.2 trillion.

Of that, about a third might default (many more from the last period of the lending binge, when standards simply vanished), which would indicate losses of about $380 billion. Of that, about 60 percent will be recovered when the houses are seized in foreclosure and, after the legal fees are paid, sold to shrewd buyers. That leads to a net loss to pension funds, municipalities, labor unions, hedge funds, and wealthy foreigners of about $150 billion, as a very rough number.

That number may be even greater when upwards of $40 billion in losses on mortgages call Alt-A's -- where the borrowers didn't have poor credit, but the interest rates reset too high for them to afford -- are added. If we also assume that defaults might be even greater on mortgage pools sold since the middle of 2007, the total unrecoverable losses will be about $200 billion to $250 billion. Ouch!

On top of that, there are losses on structured investment vehicles, in which speculators basically borrowed short-term money to buy long-term debt -- always risky -- and possibly some losses on car loans as well, but that's not yet clear. There are also losses to hedge funds, which are loosely regulated pools of investments, but their accounting is generally murky.

Still with me? Because there's light at the end of the tunnel.

The Usual Suspects

But first, here are some amazing facts about this debacle: As far as I know, not one person on Wall Street has been even indicted for, let alone convicted of, fraud. Not one. In fact, the leaders of the major investment banks, banks, and brokerages that sold this worthless stuff -- and kept some of it in-house, leading to immense losses for their firms -- have been retired with immense severance bonuses.

The former head of Merrill Lynch -- who led his firm to near ruin by selling this garbage, and led his clients (whom he had a fiduciary duty to always put first) to disastrous losses -- was given a retirement package of about $160 million. The people at the banks who supervised this meltdown were routinely paid multimillion dollar wages per year.


His estimate of losses is about the same as mine and I agree with him that while it may slow the economy, it will not be disastrous. One thing I think Stein needs to review though is his assertiong that brokers have a fiduciary duty to their clients. That is just simply not true. Nowhere should the adage of buyer beware be adhered to more closely than when dealing with Wall Street.

Anti Americans

In a WSJ/NBC News poll, Americans display animosity toward immigration and globalization. That both of these issues have been good for the US seems not to matter in the least:



The fear of globalization could lead to protectionism as politicians pander to the public's fears. The greatest fear I have about our economy, other than the excessive debt levels, is that our "leaders" will cave in to this pressure and restrict trade. With exports at record levels it just doesn't make economic sense and it will also make that debt burden even more onerous. If we restrict trade with China, what are the chances they will keep financing our current account deficit at the low rates available on US Treasuries?

Immigration is also necessary as our population ages. Who exactly is going to pay for all that Social Security and Medicare we've promised?

Wednesday, December 19, 2007

Summers Tax Cut?

The WSJ has an article today with the headline, "Ex-Treasury Secretary Calls for Tax Cut, Spending Plan". After reading Summers speech before The Brookings Institute though I would have to say that the headline is a little misleading.

Fiscal stimulus is critical but could be counterproductive if it is not timely, targeted and temporary. Gene Sperling’s Bloomberg column this week makes these points strongly. To respond to an incipient downturn, fiscal policy has to have its impact in a timely manner. It has to be targeted to assure that increased government borrowing translates directly into increased spending and demand. And, critically, it has to be temporary so that its effects are not offset by higher long-term interest rates. Indeed from the point of view of stimulus, the optimal package is one that raises spending and the deficit in the short run while reducing the deficit in the long run and thereby reducing long term interest rates. Any actual fiscal stimulus program would have to be worked out in the context of events as they unfold and should be walled off from longer term policy considerations where actions to assure long term fiscal sustainability are essential.

It is reasonable to suggest that stimulus approaching $50-$75 billion -- roughly in the range of 1/2 of 1% of GDP -- is likely to be appropriate. The largest part of this stimulus should come in the form of tax cuts distributed equally among all taxpayers and recipients of tax refunds. Other elements of a stimulus package should include extension of unemployment insurance benefits given that long term unemployment is already at recession levels, temporary step-ups in food stamp benefits which can be executed and have effect very quickly, and tax measures to eliminate from taxation the so-called income that homeowners receive when they are foreclosed, a step that has just been passed by Congress.


Temporary tax cuts will not have the fiscal impact that is needed. Every time temporary tax cuts have been tried in the past they have not had the intended impact. Since taxpayers know that the cut is temporary, they tend to save a large portion of it rather than spend it and the stimulus is muted. Likewise, extending unemployment benefits will not be effective at reducing long term unemployment. A corporate tax cut would be much more effective.

Summers proposal is nothing more than a band aid and one that will be unlikely to have much impact on the economy.

Fed Loans at Discount to Discount Rate

The results of the Federal Reserve's Term Auction Facility are in. The Fed loaned $20 billion to banks at 4.65%. That's less than the Discount rate of 4.75% but not dramatically so. Banks bid for about $60 billion so there was strong demand for the loans. Interestingly though, it is a fraction of what the ECB loaned out to European banks earlier in the week ($500 billion). Are European banks in more trouble than their US counterparts?

Here's an interesting paragraph in the AP story:

The smooth flow of credit is the econony's life blood. It permits people to finance big-ticket purchases, such as homes and cars, and helps businesses to expand their operations and hire workers.


Credit is the life blood of the economy? That is certainly true in our over indebted economy, but the lifeblood of any economy is saving and investment - of which we have way too little.

Nanosolar

This is pretty cool.


Well-financed solar start-up Nanosolar on Tuesday said it has started shipping its flexible thin-film solar cells, meeting its own deadline and marking a milestone for alternative solar-cell materials.

On the company's blog, CEO Martin Roscheisen announced that the first megawatt of its solar panels will be used as part of a power plant in eastern Germany.

The release of Nanosolar's first products is significant because the company develops a process to print solar cells made out of CIGS, or copper indium gallium selenide, a combination of elements that many companies are pursuing as an alternative to silicon.

The 5-year-old company, based in San Jose, Calif., has raised more than $100 million in financing and has drawn in Google founders Sergey Brin and Larry Page as investors.

Because of the high price of silicon, several companies are making thin-film cells from CIGS, but a number have run into technical problems.

Roscheisen said the manufacturing process the company has developed will enable it to eventually deliver solar electricity for less than a dollar per watt, which would be significantly cheaper than fossil fuel sources of power generation


I've been following the solar industry for over 15 years and the improvements in efficiency over the last 5 years are simply stunning. If Ray Kurzweil is right about the singularity, the next 5 years should be even more exciting. I can't wait for the day when solar power drops in price to be competitive with conventional sources without subsidies. I wonder if OPEC is keeping oil prices high because they know their days of power over the market are numbered?

Tuesday, December 18, 2007

America on Sale for Canadians

The Canadian dollar is at about parity with the US dollar now after years of trading at a discount. The change has come rapidly; the Loony was trading at about 85 cents as recently as February of this year. The change in the currency value is impacting trade between the two countries. The article linked above is from The American and highlights the macro economic changes that will likely result from the rising Canadian currency:

When I was a kid growing up in Detroit, my mother once said that she loved to visit Canada, right across the river, because “everything there is on sale.” It certainly seemed that way when the Canadian dollar traded at a fraction of the value of the U.S. dollar.

Today, of course, the situation is reversed: the U.S. dollar has been declining against major currencies, while the Canadian dollar has been rising. Over time, this could transform the largest bilateral trading relationship in the world and bring major changes to the Canadian economy. It will also affect the United States, since supply chains in virtually every sector of the American economy cross the 49th parallel.

For decades, Canadian firms have relied on a low Canadian dollar to cover the gap in labor productivity with U.S. companies (who invest more heavily and often in automation) and to attract U.S. investment. The low Canadian dollar has helped Canadian commercial service firms to compete in the U.S. market and has lured millions of American tourists and convention visitors. But now, in sectors ranging from manufacturing to services, Canadian exporters are finding that the high dollar makes them more expensive for U.S. customers.


A more important impact for the immediate outlook for the US economy is highlighted in this article from the AP:

CHANDLER, Ariz. - Two hours after his flight landed in Phoenix, Calgary resident Doug Farley already was cruising the city's vast stuccoed suburbs in search of the one attraction Canadians cannot seem to get enough of these days: cheap homes.

There are thousands of them here: almost new, unoccupied and dropping in value. The mortgage meltdown, combined with a surging Canadian currency, has Farley — and many of his countrymen — dreaming of winter golf on grass that's always green.

"My dollar's the same as your dollar, finally," Farley said, grinning as he peered through a pool fence at a sparsely populated condominium complex in Chandler, a Phoenix suburb.


Surely there aren't enough Canadians to buy up all the inventory of homes in the US, but with the dollar also weak against the British pound, the Euro and the Brazilian Real, foreign buyers could certainly help to end the glut sooner than expected. I've been hearing from real estate professionals that traffic is picking up anyway and on Miami Beach the buyers are mostly Europeans and Latin Americans.

Europeans Discover Supply Side Economics

At a time when every Democratic candidate for President is proposing some kind of tax increase, it is interesting to see Europe heading in the opposite direction. Admittedly most of the tax reductions are on the corporate side but even personal rates are being reduced. Jurgen Reinhoudt has a good article at The American on the subject:

Bloomberg News reported this past May, “as leaders of the Continent’s biggest economies give up criticizing smaller neighbors for cutting business-tax rates and decide to join them instead.”

In recent years, the Netherlands has cut its corporate tax rate from 34 percent to 25 percent. Effective January 1st, Germany will slash its corporate rate from 38.7 percent to 29.8 percent, while abolishing a number of complex deductions in order to mitigate the budgetary impact. Germany’s hitherto high corporate tax rates have led to spectacular evasion, with companies hiding an estimated $82 billion per year from the taxman. Cutting rates will help change this. Plus, as Germany’s center-left finance minister, Peer Steinbr├╝ck, has said, “This corporate tax reform will make Germany a more attractive place for investment.”


And Europeans have also discovered the Laffer curve:


In the United Kingdom, the corporate tax rate has declined from more than 50 percent in the early 1980s to 30 percent today—yet tax revenues are surging. Given that the tax rate is low by recent historical standards, the spike in revenues prompted a group of British economists to write a paper asking, “Why has the UK corporation tax raised so much revenue?” Recognizing the success of lower rates, British Prime Minister Gordon Brown has announced that the corporate tax rate will be reduced from 30 percent to 28 percent in April.


Meanwhile, in the US, the corporate tax rate is stuck at 35%. US companies will find it increasingly difficult to compete with foreign companies paying much less of their profits to government.

Farm Bill Business as Usual

With farm commodity prices as high as they are one would think that something like the Farm Bill would be unnecessary. That might be true if the Farm Bill were about helping farmers; the fact that this monstrosity passed just proves that the Farm Bill is not about helping farmers - its about helping politicians get re-elected. From the WSJ:

Money may not grow on trees, but it's close enough for some gentleman farmers. Late last week, the Senate killed an attempt to limit federal subsidies flowing to farmers in the country's top income brackets.

Under the amendment sponsored by Minnesota Democrat Amy Klobuchar, eligible recipients of the government's largesse would have been capped at incomes of $750,000 per year. How draconian. That's not even halfway to the White House's proposal to end the subsidies at adjusted gross income of $200,000, a level Democrats often use to define the "rich." The amendment nonetheless went down by a revealing 48-47, well short of the 60 votes needed to defeat a filibuster.

Naturally, Senators who voted to keep subsidies for the super-rich included those from the big cotton and rice states, such as Arkansas Democrats Blanche Lincoln and Mark Pryor. Kent Conrad, the populist "deficit hawk" from North Dakota, also joined a total of 12 Democrats in opposing limits on aid for big agribusiness. Even such vocal conservatives as Richard Burr (R., N.C.), Tom Coburn (R., Okla.) and Jim DeMint (R., S.C.) voted against capping the federal handout. Ditto for outgoing pork captain Trent Lott, and Republican leader Mitch McConnell (R., Ky.), among 35 Republicans all told.

The Senate then voted overwhelmingly to pass the farm bill, which will have to be reconciled with the House version, where the income cap is a mere $2 million. Farmers will reap around $20 billion this year in federal handouts -- despite strong crop prices and rising land values -- and two-thirds will go to the wealthiest 10% of farms. Politicians justify a more powerful government in the name of helping the poor, but the farm bill proves once again that in practice it typically serves the powerful.

The Clinton Housing Bubble

Vernon Smith, a professor of law and economics at George Mason University, has an editorial in the WSJ today titled, "The Clinton Housing Bubble". The gist of the article is that the cut in capital gains taxes for real estate during the Clinton administration contributed to the housing bubble. While I think that is true I think the more important factor was the extremely low interest rates of the Greenspan Fed.

The joint housing and mortgage-market crisis once again reminds us that all financial implosions stem from the same cause: borrowing short and lending long without enough equity to weather periodic storms in the gap between.

But this bubble was different. Besides being fueled by housing purchases and repackaged loans, each with inadequate equity -- doubling down with other people's money -- at the end of the capital-gains rainbow was the right to take up to $500,000 of profit, tax free.


Mr. Smith, like the rest of the George Mason Economics department, is very free market friendly:

Consequently we have the "independent" Fed being driven by market forces to accommodate the long-evident and glaringly least-defensible features of the housing/mortgage markets. Moreover, the moment the Fed abandoned its stance against inflation, the dollar, gold, oil and commodity prices signaled inflation, and now two months later consumer prices have confirmed the signal.

More daring than the action to exempt real estate from the capital gains tax -- and in lasting service to the poor -- would have been actions allowing capital gains on all assets to go tax free, provided that the capital was reinvested -- i.e., not consumed, and yes, good citizens, housing counts as consumption.

Unlike the latest housing bubble, the stock market "excesses" of the 1990s financed thousands of new ventures, some of which found innovative ways to manage the proliferation of new technologies. The result: astonishing, long-term increases in productivity still evident in the most recent quarter.


Think for a moment what would happen to the stock market if capital gains taxes were eliminated. It's a nice thought isn't it?

Monday, December 17, 2007

Inflation

Jeffrey Tucker at the Mises website has put up a chart of PPI. Anyone who thinks we don't have inflation need only take a look at this chart.

What this chart really tells you is that the Fed is destroying the value of the US Dollar. In a hard money economy (i.e. gold standard), prices should fall as productivity increases. So not only has the Fed overcome the natural deflationary tendency in a capitalist society, they've managed to destroy the value of the existing money stock as well. Pretty impressive.

Sunday, December 16, 2007

James Grant Explains the Business Cycle

ECONOMISTS cannot reliably forecast recessions. Nor can they detect for certain when a recession is in progress. Only after the fact do the official cyclical timekeepers identify the beginning and ending dates of a slump.

Though deficient in the powers of foresight and observation, economists do believe they know how to treat an economy on the brink of recession, as this one seems to be. They administer what non-economists know as the “hair of the dog that bit you.”


And thus, James Grant begins his lesson in Austrian Economics by explaining the business cycle. In a recent essay, I talked about the buildup of debt in our economy over the last 50 years. It has caused increased indebtedness and reduced savings which does not augur well for the US economy over the long term. Grant argues that the Fed shouldn't be trying to lessen the blow of the economic slowdown:

Now what to do? Why, slash interest rates to coax forth still more lending and borrowing. It’s the customary curative, seemingly as humane as it is politic.

And if recessions served no useful purpose, it might be. But recessions do. On Wall Street, they speak of “corrections.” What corrections correct are errors in judgment. So do recessions.

They allow the sorting out of boomtime error. They permit — indeed, force — the repricing of inflated assets. In a downturn, previously overpriced businesses, houses and buildings are made affordable again.

Naturally, people hate these painful, salutary interludes. Nobody likes insecurity, bankruptcy and joblessness. So the Fed keeps slashing interest rates. And this balm does mitigate the suffering. Homeowners and businesses refinance their debts. Fewer houses are thrown on an overstocked market.


Grant is right of course, but that doesn't mean the the Fed will accomodate. That would be an admission that Fed policy to date has been a large part of the cause of our economic troubles. And I doubt that will happen.

Grant concludes with an observation that I've made previously:

Presently, a new upcycle does begin, but it’s slow off the mark. The world’s top economy seems curiously sluggish. And the economists and politicians ask, “What happened to America’s dynamic economy?” The answer: It’s wrapped in the coils of debt.


The interest rate cycle since the early 80s has been one of lower highs and lower lows. Every interest rate raising cycle ends at a lower level and every subsequent interest rate lowering cycle ends at a lower level. That makes sense; the increased debt load after each up cycle means that there is a greater headwind each time the Fed embarks on a rate cutting cycle.

The question we face today as investors is this: "Has the economy finally been larded up with so much debt that it will not recover during this rate cutting cycle?" As long time readers know, I don't think so. I believe that the US economy can overcome the ill effects of high debt at least one more time. The real danger will come in 2009 or 2010 when tax rates rise. I suspect that will be a very ugly recession whether economists are able to predict it or not.

Thursday, December 13, 2007

More on Farm Subsidies

I know I've been writing here a lot about farm subsidies (and I'm about to do so again), but I think if we could make some progress on this issue we could go move a long way toward reforming our political process. Farm subsidies, in my opinion, are the most egregious example of corruption in our political process. Politicians of both parties are guilty of pandering to the US farmer for votes at the expense of every non farming American.

I ran across this study by the Cato Institute that is very informative and easy for non economists to understand. The beginning of the article lists 6 reasons that ending farm subsidies would be beneficial:

Ripe for Reform: Six Good Reasons to Reduce U.S. Farm Subsidies and Trade Barriers



by Daniel Griswold, Stephen Slivinski, and Christopher Preble


Daniel Griswold is director of the Center for Trade Policy Studies, Stephen Slivinski is director of budget studies, and Christopher Preble is director of foreign policy studies at the Cato Institute.


Executive Summary

U.S. agricultural policies have remained fundamentally unchanged since the 1930s. Today the U.S. government continues to subsidize certain farm commodities through direct price supports and tariff rate quotas that limit imports. Americans pay a high price for this ongoing government intervention in agricultural markets.

Reducing farm subsidies and trade barriers would benefit Americans in six important ways. One, reform would deliver lower food prices to tens of millions of American households, especially lowincome families that spend a large share of their income on food. Last year U.S. farm programs transferred $16.2 billion from U.S. food consumers to producers.

Two, reform would lower costs for U.S. industries, such as confectioners and other food processors, that use agricultural commodities in their final products and would promote trade negotiations to open markets abroad for U.S. exporters.

Three, reducing farm subsidies would save U.S. taxpayers tens of billions of dollars during the next decade. Many of those subsidy payments currently go to large farms and agribusinesses, not to smaller "family farms."

Four, agricultural reform would enhance the environment by reducing the amount of top soil lost and damaging fertilizers and pesticides used by American farmers. It would liberate farmland to be used for reforestation, recreation, and other more environmentally friendly purposes.

Five, agricultural reform would benefit farmers themselves by promoting production of crops that are in demand by consumers. Farm reform would stimulate innovation and productivity gains on the farm and promote more economic diversity and dynamism in rural communities.

Six, lower farm trade barriers would raise incomes of farmers in poor countries, reduce global poverty, create a more hospitable climate abroad for U.S. foreign policy, and enhance U.S. security.

Congress and the president should seize the opportunity presented by the Doha Round negotiations of the World Trade Organization and the next reauthorization of the farm bill to fundamentally reform U.S. agricultural policy.



If we could end farm subsidies, it would move us a good deal closer to the goal of truly free trade. The benefits to the country and all Americans is obvious.


Cato also has a plan to get rid of the subsidies in a way that should limit the political damage:

Agricultural policy in the United States is interventionist, expensive, inequitable, and damaging to American interests abroad.Over the last 20 years, the opportunity cost to American consumers and taxpayers of supporting agricultural producers has totalled over $1.7 trillion.The harm to agricultural producers abroad, including many developing countries, does not help U.S. foreign policy. American intransigence over reducing farm subsidies is a significant impediment to a successful conclusion to the Doha round of world trade talks. It is time for the government to get out of the business of managing agricultural markets and supporting the incomes of farmers, many of whom are relatively well-to-do.

Removing barriers to agricultural imports will provide cheaper food for consumers and inject competition and dynamism into agricultural markets. Democrats took Congress partly by criticizing fiscal irresponsibility. Dismantling farm income support programs is a perfect opportunity to make good on the promise to make changes for the better.

Because the first-best solution of completely ending farm programs as of September 30, 2007--with no compensation or transition payments--is politically infeasible, we advocate that the government buy out the damaging and expensive support for farmers by paying them a fixed amount of money, which they would be free to spend as they wish. Although it would require large up-front outlays, a politically expedient buyout of agricultural subsidies and trade barriers, with concrete steps to ensure the changes are permanent, would be a worthwhile investment. The 2007 Farm Bill provides an opportunity for less government interference with rural America.


Some might say this is just throwing good money after bad, but if we could do this once and be done with farm subsidies forever, it would be worth it.

Wednesday, December 12, 2007

Tortillas or Ethanol?

Robert Samuelson is not my favorite economist but he gets one right today in this editorial in the Washington Post:

If people can't eat, they can't do much else. One of the great achievements of the past century has been the enormous expansion of food production, which has virtually eliminated starvation in advanced countries and has made huge gains against it in poor countries. Since 1961, world population has increased 112 percent; meanwhile, global production is up 164 percent for grains and almost 700 percent for meats. We owe this mainly to better seed varieties, more fertilizer, more mechanization and better farm practices. Food in most developed countries is so plentiful and inexpensive that obesity -- partly caused by overeating -- is a major social problem.

But the world food system may now be undergoing a radical break with this past. "The end of cheap food" is how the Economist magazine recently described it. During the past year, prices of basic grains (wheat, corn) and oilseeds (soybeans) have soared. Corn that had been selling at about $2 a bushel is now more than $3; wheat that had been averaging $3 to $4 a bushel has recently hovered around $9. Because feed grains are a major cost in meat, dairy and poultry production, retail prices have also risen. In the United States, dairy prices are up 13 percent in 2007; egg prices have risen 42 percent in the past year. Other countries are also experiencing increases.


The problem is farm subsidies for ethanol:

It's the extra demand for grains to make biofuels, spurred heavily in the United States by government tax subsidies and fuel mandates, that has pushed prices dramatically higher. The Economist rightly calls these U.S. government subsidies "reckless." Since 2000, the share of the U.S. corn crop devoted to ethanol production has increased from about 6 percent to about 25 percent -- and is still headed up.

This is not a case of unintended consequences. A new generation of "cellulosic" fuels (made from grasses, crop residue or wood chips) might deliver benefits, but the adverse effects of corn-based ethanol were widely anticipated. Government subsidies reflect the careless and cynical manipulation of worthy public goals for selfish ends. That the new farm bill may expand the ethanol mandates confirms an old lesson: Having embraced a giveaway, politicians cannot stop it, no matter how dubious.


I've said it before and I'll say it again; free trade is a moral issue. If the cost of producing ethanol from corn is one hungry person, it is too high.

Central Bank Collusion

So what exactly is the Fed up to? Yeseterday, they lowered the Fed Funds and Discount rates by 25 basis points and the market reacted poorly to say the least. So today a new plan to address the credit crunch is offered:

WASHINGTON (AP) -- The Federal Reserve on Wednesday announced a novel approach to injecting money into the banking system as it struggles to combat a severe credit crunch that threatens to drag the country into a recession.

The Fed said it would conduct two auctions next week where banks can bid for up to $40 billion in loans, money that they will have to bolster their own reserves. It marked the Fed's biggest concentrated effort to inject liquidity into the banking system since the Sept. 11, 2001, terrorist attacks.

The Fed linked the new auction process to an announcement that it was extending a line of credit in dollars to the European Central Bank and the national bank of Switzerland so that those institutions could better deal with credit problems in Europe. The Fed said it was also coordinating with the central banks of England and Canada.


Obviously, this wasn't cooked up over night so it has been in the works for some time, but the question is the timing. Was this in the hopper ready to go in case the rate cut didn't work? Or is this something that would have happened anyway? My guess is the former and when the market gave a thumbs down yesterday, the Fed decided to go with Plan B. From the looks of the market this afternoon, they may want to consider Plan C, whatever that is.

One thing that puzzles me about this plan is that it appears to be a sort of short term lowering of the discount rate. If the Fed wanted to loan money at a lower rate, why didn't they just lower the discount rate more? How is this better? The bottom line here though is that the Fed is attempting once again to get the credit machine functioning again. It seems that the only tool our government ever considers anymore to increase economic growth is monetary. If the economy is in that much trouble wouldn't it be better to be considering fiscal measures such as tax cuts? In fact, wouldn't it be much better for the economy in the long run to leave interest rates where they are and lower corporate and individual tax rates? Why is the extension of credit seen as the only way to improve economic performance? It seems to me that easy credit is what got us in this mess; how is providing more easy credit going to solve the problem?

The Mortgage Fix

Llewellyn Rockwell has an article about the mortgage bailout at Mises. Rockwell is an inflexible libertarian, but he knows his economics:

Joy, joy, the Fed has cut rates again. Picture the Joker from the movie Batman throwing money from his float on the parade and you can see where this is going. Or imagine the alchemist of medieval lore, attempting to conjure up wealth from chemical mixtures.

The sea of inflationary credit is the core problem behind the falling dollar, the subprime crisis, the housing meltdown, not to mention the rise in the national debt and a thousand other problems.

And how do they deal with it? More credit and more calls for controls. No one in Washington seems to understand the reason for the crisis, much less how to fix it. The markets go for this stuff for a while until it looks like Washington is in panic mode. Even Wall Street is starting to sense that something is very wrong.

A good indication is President Bush's freeze on subprime mortgage rates. It is a classic case that provides serious lessons for all of us. It shows the political penchant for intervening in the market, the market response, and the further interventions that are called forth when the first round doesn't bring the utopia they imagine.


Rockwell covers the source of the sub prime market. As usual it has government intervention written all over it:

The incredible fact is that these loans are an expected result of 15 years of government propaganda about mortgage loan "discrimination." Some genius noticed that the loan markets tend to favor people with good credit histories and some savings built up over time. And then some other genius noticed the demographic fact that these credit histories, in general, parallel racial demographics. Hot button! And so the pressure was on to lend as if the prospect for repayment didn't matter.

The portfolio of loans in this category were only viable if we presumed that housing equity would rise forever. Then it works like magic. It's like an economic perpetual-motion machine. You borrow and borrow and the loan pays itself off. Crazy? Yes, it is, but such is the craziness of any inflationary environment. It leads people who should know better to believe that the impossible is happening.


Rockwell, like every good Austrian economist, sees the Federal Reserve and other government intervention in the market as the source of most, if not all, evil in the world. I wouldn't go that far, but in this case, I think I have to agree.

Tuesday, December 11, 2007

Jimmy Carter Almost Makes Sense

Former President Jimmy Carter has an editorial in the Washington Post today about farm subsidies. He almost finds the right answer, but alas he can't quite get over the hump. First he recalls the history of farm subsidies in the US:



A long-overdue debate is taking place on reform of the 1933 farm bill, passed during the Great Depression to alleviate the suffering of America's family farmers. I was a farm boy then, and the primary cash crops on my father's farm were peanuts and cotton. My first paying job was working for the U.S. Department of Agriculture, measuring farmers' fields to ensure that they limited their acreage and total production in order to qualify for the life-sustaining farm subsidy prices.


That brings to mind a quote from Milton Friedman: "Nothing is so permanent as a temporary government program." Why are we still paying subsidies that were first enacted to alleviate suffering during the Great Depression? Didn't that end already?

Carter then goes on to talk about the things most of us already know about agriculture subsidies - they are not for the small farmer; most of the subsidies going to wealthy individuals or large corporations. Here's a good source about who really gets farm subsidies.



It is embarrassing to note that, from 1995 to 2005, the richest 10 percent of cotton growers received more than 80 percent of total subsidies. The wealthiest 1 percent of American cotton farmers continues to receive over 25 percent of payouts for cotton, while more than half of America's cotton farmers receive no subsidies at all. American farmers are not dependent on the global market because they are guaranteed a minimum selling price by the federal government. American producers of cotton received more than $18 billion in subsidies between 1999 and 2005, while market value of the cotton was $23 billion. That's a subsidy of 86 percent!

The Carter Center works primarily among the world's poorest people, including those in West Africa whose scant livelihood depends on cotton production. For instance, in 2002 Burkina Faso received 57 percent of its total export revenue from cotton, while Benin depended on cotton exports for more than 75 percent of its national export revenue. Overproduction in the United States leads to the dumping of U.S. cotton on global markets, which drives prices down. In recent years, cotton exported from the United States has been sold 61 percent below its cost of production.

Fragile African economies that depend on agricultural exports, especially cotton, are sometimes devastated by these practices. A 2002 report by Oxfam International estimates that in 2001 sub-Saharan Africa lost $302 million as a direct result of U.S. cotton subsidies, with two-thirds of the loss sustained in eight countries -- Benin, Burkina Faso, Mali, Cameroon, Ivory Coast, Central African Republic, Chad and Togo. Compared with American humanitarian assistance, the subsidies to U.S. cotton farmers amount to more than the U.S. Agency for International Development's total annual budget for all of sub-Saharan Africa.


So now that he's properly diagnosed the problem it would seem a short leap to the answer to this vexing problem: No subsidies and Free Trade. But is that where Carter goes? Um no:

Two amendments being proposed in the Senate represent the best hopes for fixing what's wrong with the system of crop subsidies. Sens. Richard G. Lugar (R-Ind.) and Frank Lautenberg (D-N.J.) have proposed the Farm, Ranch, Equity, Stewardship and Health Act of 2007 as an amendment to the farm bill; it would replace the subsidies with an insurance program protecting farmers from excessive losses and catastrophes such as flooding or drought. This approach would correct many of the flaws I've noted in the current farm bill. An amendment being circulated by Sens. Byron Dorgan (D-N.D.) and Charles E. Grassley (R-Iowa) would place a $250,000 cap on annual subsidy payments to a farmer. Various schemes under the present law allow these limits to be grossly exceeded, with some big farmers receiving several million dollars annually. Both amendments would go a long way toward making the farm bill fair for farmers at home and abroad.


Why can't farmers buy their own insurance? Why should I pay to make sure their business makes a profit? Can I get some of this Federal gravy? And a $250,000 cap? Isn't that a tad generous? By the way, the House just passed a farm bill that puts an income cap of $2,000,000 on farmers who receive payments. What the hell do they need subsidies for?

Carter makes the best case for the elimination of the subsidies and free trade in the last paragraph:

I am still a cotton farmer, and I have been in the fields in Mali, where all the work is done by families with small land holdings. Cotton production costs 73 cents per pound in the United States and only 21 cents per pound in West Africa, so American farmers do need protection in the international marketplace. But Congress has a moral obligation to protect American agriculture with legislation that will serve our national interests, that will feed hungry people and that does not suppress the ability of the poor to work their way out of poverty.


If Mali farmers can produce cotton for 21 cents a pound shouldn't we let them do it and buy our cotton from them? I think there might even be an economic term for this....oh yeah, comparative advantage. I know it's a new concept - Ricardo only came up with it 190 years ago - but you would think politicians would have heard of it by now.

Sell the News

There's an old saying on Wall Street: "Buy the rumor, sell the news". They seem to be really taking that one to heart this afternoon. The Fed cut the Fed Funds and Discount rates by 25 basis points and pleased exactly no one. A consensus had formed around the idea that the Fed would cut the Funds rate by 25 and the discount rate by 50 basis points due to the continued turmoil in the credit markets. Since it didn't get what it wanted, the market is throwing a bit of a tantrum - down about 220 on the Dow right now. It'll be interesting to see if things can recover a bit before the close.

The Fed Meeting

The FOMC meets today to decide the course of interest rates. My best guess is a cut of 25 basis points in the Fed Funds rate and 50 basis points in the Discount Rate, but who knows. The statement is likely more important than the action anyway. I would also not be surprised if they left the Fed funds rate unchanged and just adjusted the discount rate. That would be a surprise to the market though.

Monday, December 10, 2007

Political Satire

The Mises blog has an excellent post on political satire. A few excerpts:

"Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself." Mark Twain

"If you make any money, the government shoves you in the creek once a year with it in your pockets, and all that don't get wet you can keep." Will Rogers

"Politics is the art of looking for trouble, finding it, misdiagnosing it, and then misapplying the wrong remedies." Groucho Marx

"Giving money and power to government is like giving whiskey and car keys to teen-age boys." P.J. O'Rourke

"In our civilization, and under our republican form of government, intelligence is so highly honored that it is rewarded by exemption from office." Ambrose Bierce

"If a politician found he had cannibals among his constituents, he would promise them missionaries for dinner." H.L. Mencken

The Mother of All Bad Ideas

Peter Schiff at EuroPacific Capital rips the Bush sub prime bailout plan:

Without question, the Bush administration’s mortgage rescue plan will exacerbate, not alleviate, the problems in the housing market. As the plan will sharply reduce the ability of new buyers to make purchases, it really amounts to a stay of execution and not a pardon.

Ostensibly, this plan is being offered in an attempt to stem the tide of foreclosures that might otherwise cause further weakness in home prices. The reality of course is that current home prices are still too high, having been a function of the lax lending standards and rampant real estate speculation that got us into this mess in the first place. A return to prudence in lending also means a return to prudence in pricing. Everyone seems to agree that a return to traditional lending standards is a good idea, but no one seems willing to accept a return to rational prices as a consequence. The government’s attempt to orchestrate such an outcome is doomed to failure, as it is impossible to maintain bubble prices after the bubble has burst!

The final absurdity is the Government’s attempt to portray their plan as voluntary. Of course the authorities point out that if their “suggestions” are not adopted by lenders, much more draconian legislation will surely follow. Let freedom ring.


The sneer in that last sentence is priceless.

Skyscraper Index

Apparently there is a correlation between the building of really tall buildings and the business cycle:

The skyscraper is the great architectural contribution of modern capitalistic society and is even one of the yardsticks for twentieth-century superheroes, but no one had ever really connected it with the quintessential feature of modern capitalistic history—the business cycle. Then in 1999, economist Andrew Lawrence created the “skyscraper index” which purported to show that the building of the tallest skyscrapers is coincidental with businesscycles, in that he found that the building of world’s tallest building is a good proxy for dating the onset of major economic downturns. Lawrence described his index as an “unhealthy 100 year correlation.”


This website would seem to be a bad omen.

Ron Paul Interview

I don't talk about politics much here for obvious reasons, but since Ron Paul is getting more attention than any libertarian candidate ever, I've decided to make an exception. The link above is to an interview with Ron Paul conducted by John Stossel for 20/20.

Gore Emits Hot Air in Norway

Al Gore accepted the Nobel Peace Prize today for....well I'm not sure exactly what he did to promote world peace but it must have been something. Oh yeah, global warming fear mongering.

I do not view global warming or climate change in general as an imminent problem that requires massive government intervention to save us from ourselves. Maybe that's because I'm old enough to remember that the same folks who are now warning about global warming were warning about global cooling back when I was an impressionable teenager.

I am concerned about the response to global warming though. The various proposals may not affect the global climate but they will surely affect the global economy. If we are to enact Kyoto or some successor economic suicide pact, I think we need to be damn sure about the science and whether we really need to do this.

That being said, here are a few things that I find troubling:

1. This website is surveying all the temperature monitoring sites to see if they meet the criteria set forth by NASA and NOSA. The vast majority so far do not. Monitoring stations are near parking lots and other heat sources that make the temperature measurements inaccurate.
2. Many in the global warming industry like to say that recent years were the warmest on record. The only problem is that it isn't true. NASA had a programming error in one of the programs they use to crunch the raw data. Once that was fixed the warmest year of the 20th century turned out to be 1934. And 2000, 2002, 2003, and 2004 were cooler than 1900.
3. Scientists are hyping any data that supports their preconceived conclusions. Al Gore and others have said publicly that it is okay to exaggerate because its the only way to get the public to pay attention. Al Gore: "Nobody is interested in solutions if they don’t think there’s a problem. Given that starting point, I believe it is appropriate to have an over-representation of factual presentations on how dangerous it is, as a predicate for opening up the audience to listen to what the solutions are, and how hopeful it is that we are going to solve this crisis."
Stephen Schneider of Stanford University: "To reduce the risk of potentially disastrous climatic change, scientists must capture the public’s imagination. That, of course, entails getting loads of media coverage. So we have to offer up scary scenarios, make simplified, dramatic statements, and make little mention of any doubts we might have. Each of us has to decide what the right balance is between being effective and being honest. I hope that means being both.”

Al Gore is a self interested charlatan who deserves our scorn, not the Nobel Peace Prize.

Bailout for Whom?

Alan Reynolds has a sobering look at the "sub prime bailout" today on the editorial page of the WSJ:

In reality, the only financial aid in this plan goes to those who qualify for the five-year freeze on mortgage rates -- a curiously selective little group, estimated to number between 145,000 and 360,000.

When it comes to resetting mortgage payments below the level borrowers agreed to, why give a special deal to Sam but not Suzie? On the day the plan was unveiled, the Mortgage Bankers Association reported that 0.78% of mortgages went into foreclosure in the third quarter, and that 5.59% were far behind in their payments. Neither group qualifies for any help under the Bush plan. Neither does anyone with imperfect timing -- those who took out a mortgage before 2005 or after this July. Among the few lucky enough to slip through that narrow window, the primary criterion for a rate freeze is a weak credit rating, below 660. And what happens after five years? Presidential contender Sen. Hillary Clinton is already talking about stretching it to seven years, and that bidding war has just begun.

On the face of it, these criteria for political favoritism seem only marginally more sensible than limiting special loan terms to, say, short people or redheads.


The result of this "bailout" will be negative for future sub prime borrowers and will just prolong the agony of the housing market adjustment. Considering the limted pool of borrowers that this plan is supposed to help it would obviously be better if this just died a quiet death.

Saturday, December 08, 2007

UNARMs

Mark Steyn's recent column about the housing bailout is classic Steyn:

Last week the Bush administration decided to "freeze" for five years the interest rates of certain types of mortgages. You've probably caught the tail end of news stories about "subprime" home loans, lots of foreclosures, etc. Never a happy moment when the bank takes the farm.

So now the government has stepped in and said that, if you fall into a particular category of adjustable-rate mortgage (ARMs, in the biz) and you're worried that it's getting way too adjustable, don't worry: The Nanny State is about to readjust it well inside your comfort zone. By fiat of the Treasury secretary, your adjustable-rate mortgage is henceforth an unadjustable adjustable-rate mortgage. These new UNARMs will spread their healing balm across the land until it's safe enough for the housing "market" to once again be exposed to market forces.


Steyn also has some advice for politicians on religion. Read the whole thing - Steyn never dissapoints.

Investor Sentiment

The AAII released its member poll:

AAII Index
Bullish 40.7%
Bearish 39.8
Neutral 19.5

The big jump in bullish sentiment reflects the market action of the last two weeks. If sentiment continues to rise (and I suspect it will into the end of the year), we will start looking for a market correction. There are still too many bears to be overly concerned.

CIBC Discovers Basic Economics

CIBC has discovered a basic principle of economics - lowering the price of something tends to increase demand. Okay that's a little harsh, but in their latest Economics and Strategy, they discuss the paradox of increased energy efficiency and its effect on overall demand:

The OPEC oil shocks spawned huge improvements in energy efficiency, particularly insofar as oil was concerned. But three decades later, we find that the net effect of all of those efficiency initiatives has been to increase the world’s appetite for crude. While oil per unit of GDP has fallen impressively in large energy-consuming economies like the United States, total oil consumption, and indeed, total energy consumption, continue to grow by leaps and bounds. The increase in energy usage has dwarfed the gains in economic efficiency. Hence, instead of tapping energy demand, what we observe is that improvements in energy efficiency
lead to ever and ever-greater levels of energy usage.


Since increased efficiency is merely another way of saying the price has fallen, the results of their study should not be surprising.

Book Recommendations

Arnold Kling has a list of economics book recommendations at TechCentralStation.com. The only selection I've read is Charles Koch's "The Science of Success" which I found a bit dry.

Surge Working?

In September, Michael Greenstone, an economics professor at MIT, wrote a paper about judging the effect of the surge in Iraq. His conclusion, based on Iraqi bond prices, was no:

This paper shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today's Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there is a sharp decline in the price of those bonds, relative to alternative bonds. The decline signaled a 40% increase in the market's expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.


Mr. Greenstone may need to update his study:

Dec. 7 (Bloomberg) -- Holders of Iraqi bonds are giving President George W. Bush a vote of confidence.

The country's $2.7 billion of 5.8 percent bonds due in 2028 returned 15.2 percent since July, according to JPMorgan Chase & Co. index data. Only Ecuador's debt gained more, rising 18 percent. Iraq's securities yield 6.21 percentage points more than Treasuries, the most of any dollar-denominated government debt.


Who knows if the current conditions in Iraq will last, but it seems, at least for now, that things are getting better. Another factor may be that oil production is back up to 2.5 million barrels a day which is roughly comparable to what it was before the war. And a big drop in the price of oil could have a dramatic impact on the price of the bonds regardless of any military success. Cautious optimism would seem to be the appropriate stance.

Friday, December 07, 2007

Fear

Brian Wesbury has an editorial in the WSJ today. It should be required reading for every investor:

You can't move these days without bumping into an economic pessimist. "Recession in America looks increasingly likely," said the Economist magazine on Nov. 17. Two days later, in the International Herald Tribune, Nobel Prize winner Paul A. Samuelson brought up the specter of the Great Depression. And then, on Nov. 26, former U.S. Treasury Secretary Larry Summers wrote in the Financial Times that, "the odds now favor a recession that slows growth significantly on a global basis."


Wesbury is skeptical of government intervention in the economy:

This desire for government intervention to fix problems that grown adults have created for themselves is dangerous. Constantly counting on the government to save the economy undermines confidence in free markets, conditions people to believe they don't have to live with bad decisions, and creates a willingness to take imprudent risk. Actions to stabilize the economy in the short term can destabilize it in the longer term, and set the stage for even more intervention to fix the new problems at a later date.


The self limiting effects of fear will prevent a recession:

Moreover, all this pessimism makes serious economic problems less likely. If it really happens, a recession in the next year could be the most anticipated ever. That fact alone makes it improbable. Recessions usually surprise the consensus. When a recession is expected, the odds of rapidly rising inventories, excessive investment, or a surprise drop in new orders are reduced.


I have been saying for a year now that the housing problems would not cause a recession and the more pessimistic the press and the public get, the more confident I am of that prediction. The fear in markets works in a similar fashion. If investors sell short, they are creating future buying power as they will have to buy to cover the short. If they seek protection in the option market by purchasing puts, the market maker will sell stock short to hedge his position creating further future buying. When you see fear and pessimism like this, long term investors should get excited.

Read all of Wesbury's excellent editorial. It warms a contrarians heart.

Thursday, December 06, 2007

Incentives Work

As a self-employed software engineer, Thomas Sorensen broadcasts his qualifications to potential employers across Europe and the Middle East. But to the ones in his native Denmark, he is simply unavailable.

Settled in Frankfurt, where he handles computer security for a major Swiss corporation, Sorensen, 34, has no plans to return to the days of paying sky-high Danish taxes. Still, an unknowing headhunter does occasionally pass his name to Danish companies.

Born and trained at Denmark's expense, but working - and paying lower taxes - elsewhere in Europe, Sorensen is the stuff of nightmares for Danish companies and politicians searching for solutions to an increasingly desperate labor shortage.


In a world where labor and captial are mobile, incentives such as tax rates matter. Tax too much and capital or labor will go elsewhere.

Baptists and Bootleggers

Via Russell Roberts Cafe Hayek blog:

We should be realistic about politicians. George Stigler used to contrast his theory of politics with Ralph Nader's. In Nader's view, all of the ugly aspects of government were caused by the wrong people getting elected. If we could just elect better people, then we'd get better policies. Stigler argued that it didn't matter who the people were—once they got in office, they responded to incentives. They would convince themselves that they were doing the right thing, either because they really thought so or because doing the wrong thing was necessary in order to be able to do the right thing down the line.

Being a Stiglerian in this area, I expect less of my politicians and I am rarely disappointed. Even those politicians we think of as principled, pursue the calculus of the bootleggers and Baptists. Ronald Reagan, an eloquent defender of free trade, imposed "voluntary" quotas on Japanese cars. That is the way the world works.


This is the best argument for smaller government that can be made. Politicians, of whatever party, almost always do the wrong thing.

Wednesday, December 05, 2007

Automatic Fiscal Stimulus

Martin Feldstein has an editorial today in the Wall Street Journal entitled, "How to Avert Recession".

The American economy is now very weak and could get substantially weaker. Current economic conditions call for lowering interest rates and for enacting a tax cut now that is conditioned on economic developments in 2008. More generally, fiscal policy should be considered in the future whenever there is a risk that an excessively easy monetary policy could cause an asset-price bubble.


So far, so good. Feldstein then goes on to say that interest rate cuts may not be sufficient to avert a recession:

Because of current credit market conditions, there is a risk that interest rate cuts will not be as effective in stimulating the economy as they were in the past. The current credit crunch reflects not only a lack of liquidity, but also a lack of confidence in the creditworthiness of counterparties and in the accuracy of asset prices. This problem is now being compounded by the banks' loss of capital as they recognize past losses, and by their need to use large amounts of the remaining capital to support existing off-balance-sheet credits that have to be shifted to their balance sheets. All of this implies that lower interest rates may not raise lending and economic activity to the same extent that they did in the past.



Again, no argument from me. I suspect that interest rate cuts will have a more dramatic impact on asset prices than the real economy. Here's where I part company with Mr. Feldstein:

What's really needed is a fiscal stimulus, enacted now and triggered to take effect if the economy deteriorates substantially in 2008. There are many possible forms of stimulus, including a uniform tax rebate per taxpayer or a percentage reduction in each taxpayer's liability. There are also a variety of possible triggering events. The most suitable of these would be a three-month cumulative decline in payroll employment. The fiscal stimulus would automatically end when employment began to rise or when it reached its pre-downturn level.


The history of temporary fiscal stimulus schemes such as this are not good. They do nothing for the long term health of the economy. A better idea would seem to be that when the economy starts to recover, the Fed should use monetary policy to limit the stimulative effects of the fiscal package. The US economy needs lower tax rates (especially corporate taxes) that are permanent, not some gimmick short term fix.

Saturday, December 01, 2007

Delaying the Inevitable

The Treasury Secretary this week was meeting with the mortgage industry in an attempt to fashion a plan to bail out all those home owners who took out Adjustable Rate Mortgages that are due to reset next year. Why exactly is the Treasury Secretary interfering in private contracts between lender and borrower? When someone takes out an Adjustable Rate Mortgage shouldn't they have to bear the consequences when rates go up? Why should they get a free ride?

Any plan which allows homeowners to stay in houses they can't afford will only delay the day of reckoning. Eventually the rates on these mortgages will rise; will these homeowners be in any better financial shape when that finally happens? That seems doubtful; if these were prudent borrowers they wouldn't be in this position.

Another Winner in the Sub Prime Mess

There are some investors out there that managed to turn the sub prime mortgage mess to their advantage:

Nov. 29 (Bloomberg) -- The subprime crisis that's caused so much trauma for hedge funds and investment banks has brought only good news for John Paulson. He's the manager of more than $7 billion in hedge fund money keyed to mortgage credit.

Paulson started warning his investors back in the middle of 2006 that the frenzy to build and sell housing was a bubble about to pop. His New York-based firm, Paulson & Co., made big bets predicting the edifice would soon come crashing down. The wager paid off in the first nine months of 2007, when Paulson's Credit Opportunities funds rose an average of 340 percent.


There may not be a winner for every loser in the sub prime debacle but there are winners.

Sentiment

One of the things I monitor very closely is sentiment about the stock market. There are a number of ways to do this, but I've found over the years, that the best contrary indicator is the AAII poll of individual investors. These individuals are an emotional bunch and when they are bearish, the market is almost always at a bottom. Bearish sentiment has been rising all month and is now at levels that in the past have proven to be great buying opportunities. Here's the numbers for this week:

AAII Index
Bullish 28.6%
Bearish 56.1
Neutral 15.3
Source: American Association of Individual Investors,
625 N. Michigan Ave., Chicago, Ill. 60611 (312) 280-0170.

It is also instructive that even with the big rally this last week, the number of bears continues to rise. Apparently, the individual investors that make up the membership of AAII don't believe this rally is the real thing - which means it probably is.

Tuesday, November 27, 2007

What If?

The pessimism about the US economy and markets has become so extreme that I think it is time for a little reality check. So, here's a list of what ifs for you to ponder:

1. What if Citigroup writing off a year's profit (which is roughly the amount they will eventually have to write off in bad loans) is really not that big a deal? See Here
2. What if the derivatives market is a zero sum game and for every loser there is a winner? See Here
3. What if a lower dollar stimulates exports to such a degree that the economy continues to grow at 3%? See Here
4. What if peak oil is just BS and prices are peaking? See Here
5. What if the dollar is really undervalued and is near a bottom against the euro? See Here
6. What if the trade deficit means nothing significant from an economic standpoint? See Here And Here
7. What if foreign investors now view the US market as a bargain? See Here
8. What if mortgage rates follow the 10 Treasury Yield down (as the always have in the past) and mortgage resets aren't as big a problem as some think?

I'll think up more of these and post later.

Sean Taylor RIP

Sean Taylor lived only 2 miles from my house in South Dade. Taylor died this morning after being shot yesterday during a break in at his home:

Nov. 27 (Bloomberg) -- Washington Redskins safety Sean Taylor died after he was shot in the leg during a possible burglary at his Florida home. He was 24.

Taylor was found bleeding from a gunshot wound when officers responded to a call at his Palmetto Bay home just before 2 a.m. yesterday, Miami-Dade Police said.


This happening so close to home is a bit scary, but it appears the shooting was directed specifically at Tayor, so maybe it doesn't mean anything about my neighborhood. I hope so.

Sean Taylor RIP

Monday, November 26, 2007

The Real Deficit

Maybe this is why the dollar is rapidly going to hell in a handbasket?

When it comes to financial magic, the government of the United States takes the prize. Sleights of hand and clever distractions by purveyors of line-of-credit mortgages, living-benefit variable annuities and equity-indexed life insurance are clumsy parlor tricks compared with the Big Magic of American politicians.

Consider the proud trumpeting that came from Washington at the close of fiscal 2007. The deficit for the unified budget was, politicians crowed, down to a mere $162.8 billion.

In fact, our government is overspending at a far greater rate. The total federal debt actually increased by $497.1 billion over the same period.


Social Security and Medicare are problems NOW, not sometime in the future.

Friday, November 23, 2007

Optimism about the US Economy?

Amidst all the doom and gloom about the economy, its nice to see a positive article. I have maintained for some time that the US economy will not be tipped into recession by the housing or sub prime problems and I'm sticking with that position. I know its a minority view, but hey that's what makes a market. In this article from Timesonline.com (that's the UK Times not the NYT), Gerard Baker makes the case that US economy is not headed for the collapse that so many seem to want:

Much has been written about the eschatological symbolism of the dollar's fall and the financial problems that have accompanied it. The apparent consensus among commentators here in America and especially in Europe is that the US has become a kind of Third World country, awash in debt and sinking fast because of a collapsing housing market and a banking system in meltdown. And all this is supposed to reflect in turn a seismic shift in the balance of global economic power away from the US and towards Mighty Europe and Emerging Asia.


We read this kind of stuff everyday about the US economy, but as Baker points out, we've been here before:

For the historically short-sighted, let's remember we have been here before. Between 1985 and 1995, the dollar declined by 43 per cent against the world's big currencies — somewhat more than it has in the past six years. That period was also marked by dire proclamations of the end of US economic power. But it turned out that in those years the foundations were laid for the strongest period of US economic growth in the past 35 years.


And asks an obvious if little asked question:

If you're still sceptical, ask yourself this: is it probable that the shift in the relative value of the dollar and the euro represents a bet by the world's investors that Europe — strike-torn, productivity-challenged, demographically doomed Europe — is the world's economic future, rather than the US, or, let's say, China?


The sentiment about the US economy is as negative as I've seen in my entire career and there are some good reasons to be pessimistic. However, I've been hearing about the impending collapse of the US economy my entire adult life and amazingly, it hasn't happened. I doubt it is about to happen this time either. It often pays handsomely to ignore the crowd and those who are willing to see the good things about the US economy will likely be rewarded again.

Wednesday, November 21, 2007

Engineering the Dollar

The dollar is a unit of measure that changes on a minute by minute basis. Imagine if other units of measure did the same:

The U.S. dollar is in a scary slide. Gold and oil are hitting record highs, while the dollar is hitting record lows. To get how strange this all seems to an engineer like me, imagine the following headline: “Foot Falls against Meter for Fifth Straight Day.”

The accompanying article would breathlessly report that after the U.S. abandoned its “antiquated” fixed-exchange-rate system (one foot equals 0.3048 meters), our beloved foot began plunging in length. A “length trader” would predict that if the foot fell below the “psychologically important 0.2800 meter support level,” it could fall as low as 0.2500 meters. But an economist would say that as long as the foot didn’t fall more than 10 percent, everything would be okay.


The dollar needs to be fixed like other units of measure. The system outlined in this article is similar to the one that Jude Wanniski promoted for many years:

We need to approach the dollar just as we approach our other units of measure. We must first define a fundamental abstract unit of market value (“the dollar”). We must then devise a system for producing official instantiations of that unit (“dollars”) that are faithful to that definition. The dollar thus would be analogous to the foot, and dollars (the green things in your wallet) would be analogous to foot rulers produced by the U.S. Bureau of Standards...

A logical definition of the dollar might be “equal in market value to one five-hundredths of an ounce of gold.” The value of all the dollars in the U.S. monetary base would then be maintained by having the Fed’s open-market operations target the price of gold to keep it near $500 per ounce. Because the real market value of gold cannot run away to zero or infinity, the new monetary control system would be determinate and stable.

What I am describing is not a classic “gold standard.” Back then, gold was the monetary base. Instead, the monetary base would be the same “fiat” currency that we have now. Banks would maintain the value of their dollars the way they do now — by redeeming them with the dollars of the monetary base upon demand.


The dollar is making new lows again today. It doesn't have to be that way.

Tuesday, November 20, 2007

Recession Comes in 2010

This article by Kevin Hasset at the AEI explains why I expect a recession in 2010:


Since Rangel's tax hikes are focused on the rich, and the AMT is scheduled to draw ever more revenue from the middle class in federal budget estimates, the rate increases necessary to maintain current revenue levels are enormous. Rangel adds a 4.6 percent "surtax" on adjusted gross incomes above $500,000 in the first year of the law. This gives voters the impression that we are simply lifting the current top rate of 35 percent to the good old Clinton rate of 39.6 percent. But in 2011, when the Bush tax cuts expire, the surtax sticks, lifting the federal rate to 44.2 percent. Rangel also grabs revenue from the rich by phasing out exemptions and deductions. Add in the Medicare tax, and average state and local taxes, and the combined marginal income tax rate goes to 52 percent. As the accompanying chart illustrates, that would make our top marginal rate the second highest among the ten largest OECD economies, right below France.

This tax "reform" is revenue-neutral, which means that there is no money left over to fund, say, the universal health-care coverage so many of the Democratic candidates favor. If we lift the top rates to fund that too, then our rate would be far higher than that of any other major country, and begin to approach the 70 percent top rate of the 1970s.


I don't know about you but I have no desire to emulate the economic "success" of France.

Samuelson's Prescription

Paul Samuelson has done more harm to economic literacy through his Keynesian textbooks than even Keynes himself. He provides a textbook example of Keynesian meddling in this article in the IHT. His first mistake and his political affiliation is on display in the first sentence:

All through the years of the Great Depression, Wall Street publicists and President Herbert Hoover would repeatedly declare: "Recovery is just around the corner."


I don't have a problem with the part about Wall Street publicists but I find it interesting that he associates Hoover with the Great Depression rather than Roosevelt. Hoover certainly should share the blame for getting the Great Depression off to a roaring start, but Roosevelt was President during the worst of it and unquestionably prolonged the agony with his intrusive economic policies. I guess Samuelson just couldn't bring himself to criticize the icon of Democratic politics.

I love the hubris in this line:

Today, central bankers and U.S. Treasury cabinet officers cannot know whether current interest rates are too high or too low. This is surprising, but true.


Surprising? This would imply that there was a time when central bankers could know the proper level of interest rates. How exactly were they able to do that? And why can't they do it now?

His prescription for recovery is pure Keynes:

The situation is not hopeless. New, rational regulations that discourage predatory lending and rash borrowing could help a lot. Also, as we learned during the Great Depression, the government's treasury and its central bank must be both the lenders of last resort and the spenders of last resort. Speculative markets will not stabilize themselves.


Ah yes, spenders of last resort. That worked so well during the Depression. For a modern example, see Japan over the last 15 years.

And check this out:

Watch developments closely. If America's Christmas retail sales fail badly - as they could when high energy prices and high mortgage costs pinch consumers' pocket books - then be prepared to accelerate credit infusions by central banks on the three main continents.

Keep in mind threats of excessive inflation. But be aware that the skies will not fall if the price-level indices blip up from 1.9 to 2.6 percent per annum. What worsens the public's expectations about price instability are excessive spikes in the cost of living.


So the solution to a problem that developed because of excessive credit should be solved with -- more credit? And a little inflation never hurt anyone. Well not much anyway.

And on a day when Freddie Mac reports a loss of billions, Mr. Samuelson would have us expand the ability of Fannie and Freddie to lend more:

This suggests expanding in a controlled way the lending powers of quasi-public agencies such as Fannie May and Freddie Mac. Better that they should lose a bit when they help homeowners of modest means fend off foreclosures on their onerous mortgages.


It would seem that Freddie has already lost "a bit" as have the shareholders of these hybrid market/government cesspools of corruption.

How can this man have written the economics textbook used to teach the majority of adults in this country? I think the economic illiteracy of the average American has been explained.

What's More Important

The US Treasury recently released a report on income mobility in the US from 1996 to 2005. It found:

• There was considerable income mobility of individuals in the U.S. economy during the 1996 through 2005 period with roughly half of taxpayers who began in the bottom quintile moving up to a higher income group within 10 years.
• About 55 percent of taxpayers moved to a different income quintile within 10 years.
• Among those with the very highest incomes in 1996 – the top 1/100 of 1 percent – only 25 percent remained in this group in 2005. Moreover, the median real income of these taxpayers declined over this period.
• The degree of mobility among income groups is unchanged from the prior decade (1987
through 1996).
• Economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. In addition, the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups.


Most of the reports we see in the media about income distribution concentrate solely on income inequality, but it seems to me that this is much more significant. Any policy enacted to mitigate income inequality, if indeed it needs mitigating, could have adverse consequences on income mobility. Which is worse? To have a large income difference between the top and bottom quintiles? Or for someone in a lower quintile to have no hope of rising to a higher quintile? I believe we should preserve income mobility even if it comes at the expense of income inequality. In other words, opportunity is more important to our economy than assuaging envy or guilt.

Insured by Whom?

Joe Mysak has an interesting article on Bloomberg.com about the insured municipal bond market. It seems that municipalities are still lining up to get their bonds insured by MBIA, FSA and FGIC even though these insurers are deeply exposed to the subprime market and may lose their AAA ratings:

Help me with this one. At a time when nobody really knows if the nation's major bond insurers will still be rated AAA in a couple of months, municipalities are lining up to get their bonds insured. Investors, evidently, are buying them.


Apparently, the insurers have beaten a path to Warren Buffet's door:

Warren Buffett to the rescue! On Nov. 13, the Wall Street Journal carried a story saying that the bond insurers had gone to visit Omaha, Nebraska, hat in hand, and that Buffett appeared to be interested, or at least receptive. At least there were no reports that he showed them the door.


Like Mysak, I think Buffet should probably get involved. I'm sure he will be a lot better at determining the risk of what he insures than the present crew. I hope he does because if municipalities have to get ratings based on their actual creditworthiness, I suspect some bonds are about to get downgraded. My taxes are already high enough....

This Too Shall Pass

The volatility of the stock market over the last 4 months has been greater than anything we've seen since the market bottom in 2002 and it has investors worried. I am not one of them. The VIX volatility index is now trading at levels that we have seen many times before and the recent rise is typical of market corrections. It is a contrast with the low volatility of the last few years, but it certainly isn't unusual when viewed over a longer period of time.

The main reason this correction does not worry me much is that sentiment is now very negative. The AAII Poll now shows nearly 50% bears and that is not a number associated with market tops. In addition, put/call ratios are elevated indicating mounting fear in the market. Long term investors, like us, should be contemplating the purchase of long term assets in the near future.

Monday, November 19, 2007

Changing the Laws of Gravity

Here's Rep. Bill Sali (R-ID) on the minimum wage:


Mr. Speaker, a number of my colleagues have pointed out the problems with raising the minimum wage; that it is an unfunded mandate on small business, will likely result in the loss of over 1 million jobs for low wage earners, that it will eliminate entry level jobs and actually hurt the poor more than it helps them.

The negative impacts will result naturally from the rules and principles of the free market. In my college courses, I learned that the rules and principles of free markets are the rules and principles that every business and worker are subject to in every transaction, every negotiation and every new idea. That is, those negative effects of this bill are unavoidable with its passage. In spite of the negative effects, this bill does seem destined to pass.

As a freshman Congressman, the likely passage of this measure has taught me a new principle: The force of Congress can be brought to bear and justified to suspend those natural laws which would otherwise control important matters. The well-intentioned desire of Congress to help the poor apparently will not be restrained by the rules and principles of the free market that otherwise do restrain American businesses and workers. Apparently, Congress can change the rules that would otherwise affect the affairs of mankind.

So, Mr. Speaker, I have asked my staff to draft a measure I call the Obesity Reduction and Health Promotion Act. Since Congress will apparently not be restrained by the laws and principles that naturally exist, I propose that the force of gravity by the force of Congress be reduced by 10 percent. Mr. Speaker, that will result in immediate weight loss for every American. It will immediately help reduce obesity problems in America. Weight loss will also help to promote the overall health of Americans as we have been vigilantly advised by our health care.

Mr. Speaker, I thank this body for the education I have received from the passage of this bill. Since the basis for the use of Congress’s power is the same with both measures, I would also ask that everyone who is supporting the measure before us consider becoming an original cosponsor of the Obesity Reduction and Health Promotion Act, and I have a copy.

Mr. Speaker, I close by noting that, with the new principles I have learned, it appears to me that with Congress the sky is the limit.


HT to Don Boudreaux at Cafe Hayek

Monday, October 15, 2007

Banks to Fund Bailout of...Themselves

Maybe I'm just a simple country boy, but this seems like the dumbest idea I've seen since....well I'm not sure when, but certainly a long time:

NEW YORK (AP) -- The nation's three largest banks said Monday they will team up to buy tens of billions of dollars in investments that lost value after global credit markets seized up.
The plan is designed to inject more confidence into the market, and increase investor appetite for the short-term debt known as commercial paper. The market for commercial paper, which is crucial for companies to fund short-term borrowing needs, locked up this summer.


The major banks all have off balance sheet investment vehicles called SIVs which issue commercial paper and use the proceeds to buy lower rated, higher yielding securities like low rated mortgage securities. Why are they off balance sheet? The easy answer is that they don't want this toxic crap on their balance sheet, but how they get away with it is not something I've spent a lot of time pondering. Anyway, the banks are now putting together a bigger version of an SIV to buy the crap that the old SIVs can't get funding for anymore. The obvious goal is to keep this stuff off the balance sheet because if they have to claim it, the balance sheet might actually be a true reflection of their current financial condition and of course we can't have that.

In another twist, the new super massive SIV will only buy the highest rated of the crap in the current SIVs:

By buying SIVs' distressed investments, the new fund would inject enough liquidity into the market to make investors more confident in buying commercial paper.

The funds' backers said they will shy away from risky instruments and buy only highly rated, asset-backed debt -- a market that is already beginning to show signs of life.


I'm not sure how this will help the current SIVs when they will be left with only the crappiest of the crap, but then logic has never been the strong suit at places like Citigroup. The goal seems to be to appear to be doing something rather than actually accomplishing anything and this vehicle seems perfectly designed to accomplish just that.

Thursday, October 04, 2007

A Path to Socialized Medicine?

Congress recently passed a bipartisan bill with a goal of providing subsidized healthcare to millions of uninsured children in the US. The bill would fund the hugely successful State Children's Health Insurance Program, a joint state-federal effort covering 6.6 million people. The program is designed for families that earn too much to qualify for Medicare, but not enough to afford their own coverage. The bill would provide the program with $35 billion over five years to allow an additional 4 million children, under the age of 18 and under these circumstances, into the program.

President Bush had hinted that he was leaning towards vetoing the bill, and, on October 3rd, he did just that. The administration's argument consisted of claims that the bill was too costly, and that it took the program too far from its original purpose. I might be mistaken, but wasn't its purpose to provide health insurance to the needy children of the United States?

And as far as the cost, that's no big deal. We could always just borrow and borrow, until we are forced to raise the national debt limit, and then we can borrow some more. Right? Well, that seems to be the precedent being used by the government. Congress did just that last week, raising the debt cap by $850 billion to an astounding $9.815 trillion, in order to fund the ongoing war in Iraq. Can we really not afford $35 billion for our children, our future?

The administration also argued that the bill would be a move towards socialized medicine. They believe that expanding the program to higher income families would have ramifications. They believe the bill would entice families covered by private insurers to switch to the government-funded program, putting greater strain of the program.

But the bill was designed to counter that, by providing incentives for states to cover their poorest children first. And as far as it being the first step towards socialized medicine, it is way too early to know if we are indeed headed in that path. It is a fallacy to think that we would be in the midst of socialized medicine if that particular bill became a law. It may be a little less capitalistic, but it gives a lot of children the helping hand they have been hoping for.

Wednesday, September 19, 2007

Light at the End of the Tunnel...Part III

Is the light at the end of the tunnel an oncoming train bringing inflation down the tracks?

Marcelo is certainly right that the goings on in the housing market are exactly what needs to and should happen. Prices are falling and eventually they will fall to a market clearing price. Falling interest rates could also hasten that process. One fly in the ointment though is that the rates which most affect mortgage rates are not falling yet. The 10 year Treasury Note yield actually went up yesterday and is up again today. I don't expect that to continue but as long as it does, mortgage rates are not likely to fall much.

Why are rates on longer term paper not falling? My guess is that the bond vigilantes of old are making a comeback of sorts. The Fed cut interest rates yesterday to spur growth but in doing so they may also be feeding future inflation. Gold rallied almost 9% this month as the market anticipated the rate cuts. Oil is making new highs. This story sounds familiar to those of us who lived through the leisure suits and inflation of the 70s (something that Marcelo didn't have to endure).

I have said that reflation by the Fed will work and I'm sure that it will. We still have deflationary tendencies at the consumer level due to low cost imports and that allows the Fed to cut rates. The price for that cut is asset inflation for now but somewhere in the future, it will turn into actual consumer inflation (assuming the government doesn't find some new way to mask the increase through another manipulation of the CPI). I don't think we are there yet, but it will arrive someday.

As for the housing market, I think Marcelo is right - there is light at the end of the tunnel. We are probably not at a bottom yet, but if our cycle goes anything like the recent cycles in Australia and the UK, we are likely to see at least some stabilization as the Fed cuts rates. We aren't headed back to the recent past of rapidly rising prices, but we could at least begin to see some of the inventory cleared out over the next six months or so. My stance all along has been that the housing mess will not cause a recession and the Fed's rate cut yesterday just reinforces that opinion.