Thursday, May 24, 2007

Who's Gouging Whom?

The US House of Representatives recently passed a bill that makes "price gouging" a federal offense:

The legislation would give federal authorities the power during presidentially declared energy emergencies to investigate and prosecute anyone selling fuel at a price that is "unconscionably excessive" or "indicates the seller is taking unfair advantage unusual market conditions."

President Bush has already threatened to veto the legislation so this was passed for purely cosmetic reasons. Primarily so politicians can go home for the 4th of July and claim they tried to do something about gas prices. The home folks are ticked off and want the government to "do something" about gas prices:

"I was at a funeral Saturday, and when the monsignor greeted me, he said, 'My God, Bart, you have to do something about these gas prices!' " said Rep. Bart Stupak (D-Mich.), chief sponsor of the anti-gouging bill.

Rep. Sheila Jackson-Lee (D-Texas) told her colleagues: "I can't go home, and I imagine none of you can, without saying we tried to do something."

Well, I've got a suggestion; how about lowering the federal, state and local gasoline taxes? Passing vaguely defined "anti gouging" legislation, even if Bush would sign it, will do absolutely nothing about gas prices. Cutting taxes on the other hand would have an immediate and quantifiable impact. Here's what we pay in taxes for a gallon of gasoline in Miami Dade County:

First comes the Federal Government; they get: 18.4 cents per gallon. Next in line is the great State of Florida who tacks on another 17.5 cents per gallon. Finally, how could our local county commissioners miss out on the bonanza? They get 16 cents per gallon. That's a grand total of 51.9 cents per gallon. What do the refiners make? Well here's some representative companies' profit margins:

Valero (VLO) did $40 billion in revenue last year and had an operating profit margin of 9.4%. Their net margin was just 6.4%.

Sunoco (SUN)generated $9.3 billion in revenue and somehow only managed to post operating margins of just 4.4%.

Holly (HOC)is a small fry at $3.8 billion in revenue but produced the best margins of the pure refiners at 10%. Their net margin was 6.9%.

Let's not forget about the oil companies. That gasoline was produced from a barrel of oil so they get a piece of the pie as well:

Chevron/Texaco (CVX)had revenue of a whopping $172 billion and profit margins of roughly 14%.

Exxon/Mobil (XOM) is the giant with $464 billion in revenue. They also claim the prize for largest profit margin for our sample with Operating Margins of 18%. Their net (after tax) margin is only 12% though.

Yes, these companies make a lot of money. 18% of $464 billion is a lot of money any way you slice it. But are they ripping people off? Are they engaged in gouging? Could you prove with the law that just passed? I doubt it. There is a reason that Exxon/Mobil had $464 billion in revenue last year. WE BUY A LOT OF GAS.

The oil business is a capital intensive business as well. Exxon spent $15.5 billion in capital expenditures out of an after tax income of $39.5 billion. That's a reinvestment rate of almost 40% of earnings. They paid a lot of taxes too. They paid an effective tax rate of 41% of earnings in 2006. And that tax rate is not just some screwy one year thing. Their tax rate in 2005 was 39%. And 38.5% in 2004.

So, in getting back to our example, we now know how much government gets from a gallon of gasoline. How much does the oil company get? Well, let's use Exxon as the example since they have the fattest profit margin and also have refining operations. At 12% of the average retail price of unleaded, regular gas of about $3.23, that's about 38.8 cents per gallon. Of course, that's a little high because the gas station owner/operator probably gets to make something out of that retail price, but for the sake of argument, let's say Exxon gets the entire 38.8 cents. That's still less than the government makes off the same gallon of gas.

So, to all you politicians out there: the reason we are asking you to do something about gas prices is because you have the power to make a difference. Because gouging is already a federal offense. And a state offense and a local offense. It's offensive to me as a citizen when you pass meaningless legislation when you have the power to actually do something. Cut gas taxes, you morons.

Wednesday, May 16, 2007

In Defense of Free Trade

The February 26th edition of the Washington Post carried an editorial calling for punitive tariffs on Chinese goods. On February 27th, the Chinese stock market fell 8.8% and other Asian markets followed suit. European markets also succumbed and then the US market had its worst one day loss since 9/11, dropping over 400 points on the day. This past week on May 9th, Rep. Sander Levin (D, MI), chairman of the House Ways and Means Committee, convened a hearing entitled, “Is China Playing by the Rules?” in which he and other politicians accused China and Japan, among others, of unfairly manipulating their currencies to gain a trade advantage with the US. The Dow promptly dropped 150 points. Coincidence?

The honorable(?) gentleman from Michigan of course is merely responding to his constituents. Detroit automakers, rather than trying to get their own house in order, find it much easier to trek to Washington and try to gain protection from their foreign competitors through legislation. It apparently matters little that these “foreign” competitors manufacture most of their US sold goods right here in the good ol’ USA. But why should the entire automobile buying public pay the price for GM’s mismanagement?

Senators, facing election only every six years, should theoretically be able to withstand the populist impulses of their House brethren. In fact, that is how the founders envisioned Senators – as elder statesmen who would look out for the good of the country rather than their own states’ narrow interests. Unfortunately, with Senators now popularly elected, they don’t seem able to restrain themselves. Sen. Charles Schumer (D, NY) and Sen. Lindsay Graham (R, SC) have been trying to pass an odious piece of legislation that would impose 27.5% tariffs on Chinese goods unless they revalue their currency upward against the dollar by a similar amount. The damage to the Chinese economy from such tariffs is debatable; the damage to our own is not.

In the debate of the Tariff Bill of 1842, John C. Calhoun argued that when tariffs are imposed for protective purposes, “government descends from its high and appointed duty, and becomes the agent of a portion of the community to extort, under the guise of protection, tribute from the rest of the community; and thus defeats the end of its institution, by perverting powers, intended for the protection of all, into the means of oppressing one portion for the benefit of another.” It seems not much has changed since 1842, except the consequences; the “Tariff of Abomination” ultimately led to the Civil War. This latest attempt to defy the principles of economics only has the fate of our economy at stake.

Unlike the debate over global warming, which is anything but settled, the debate over free trade, at least among economists, is truly over. From Adam Smith to David Ricardo to Ludwig von Mises to Friedrich Hayek to Paul Krugman to Greg Mankiw, economists have agreed on the beneficial effects of free trade. Politicians and the general public, being unconstrained by the truth of free trade theory, are the only ones who still believe there is something to be gained through protectionism. Politicians believe, and they are probably right, they can gain votes through tariff legislation. The general public believes they can exchange some of their freedom for economic security. To paraphrase Benjamin Franklin, those who would make that trade deserve neither.

Every consumer in this country will pay for tariffs in higher prices while the benefits will be limited to narrow, politically connected interests. John C. again put it well in the debate over the 1842 tariff: “Protection against what? Against violence, oppression or fraud? If so, Government is bound to afford it…It is the object for which government was instituted. No; it is against neither violence, oppression nor fraud…Against what, then, is protection asked? It is against low prices.” Why should the majority pay for benefits that only accrue to a small minority? Politicians are trying to protect well organized, politically savvy manufacturers from the “unfair” competition of foreigners, but manufacturing accounts for only 12% of our GDP and that share has been falling since the 1950s.

Wealth and economic security cannot be gained through protectionism. Even when other countries don’t practice free trade, as certainly China and Japan do not, we benefit from free trade. “If other countries injured us by burdensome exactions, it was not reason why we should do harm to ourselves.” (Calhoun, January 27th, 1841) American ingenuity and entrepreneurship, not protectionism, are the source of our nation’s wealth. Politicians would be well advised to concentrate on providing an economic framework that allows those characteristics to flourish rather than trying to protect their friends who represent only a small slice of our economy.

The revolution in communications wrought by the internet makes trade both easier and more profitable. Politicians trying to restrict trade are standing in the way of progress. Poor countries like India and China are desperately trying to improve the living standards of their citizens while the citizens of the US enjoy unrivaled riches. How can we justify restricting trade in the name of a minority of our citizens when so many around the world suffer the indignity of extreme poverty?

"I regard free trade, as involving considerations far higher, than mere commercial advantages, as great as they are. It is, in my opinion, emphatically the cause of civilization and peace.” Like my ancestor before me, I stand in defense of free trade because I believe in freedom and I believe the path to peace is through commercial interaction with the world. Our reputation has already suffered from the arrogant prosecution of the Iraq war. We will only further injure that reputation if we also seek to restrict trade. Tariffs and other forms of protectionism such as the demand for environmental and worker protections in trade treaties are antithetical to freedom. The United States has a moral responsibility to lead the world by example and we cannot do that by restricting trade with countries that are desperately trying to pull themselves out of poverty through industry. It is both economically ignorant and morally repugnant.

Friday, May 11, 2007

Evolutionary Psychology

Paul Rubin has an article that explains opposition to free trade and immigration as being a result of evolutionary psychology:

Economists have argued for more than two centuries that voluntary trade, whether domestic or international, is positive sum: it benefits both parties, or else the exchange wouldn't occur. Economists have also long argued that the economics of immigration -- immigrants coming here to exchange their labor for money that they then exchange for the products of other people's labor -- is positive sum. Yet our evolutionary intuition is that, because foreign workers gain from trade and immigrant workers gain from joining the U.S. economy, native-born workers must lose. This zero-sum thinking leads us to see trade and immigration as conflict ("trade wars," "immigrant invaders") when trade and immigration actually produce cooperation and mutual benefit, the exact opposite of conflict.

I wonder all the time why normally intelligent people can't see the benefits of free trade - maybe this is the answer.

Tuesday, May 08, 2007

Siegel Bullish

Although the Standard & Poor’s 500 Index is still just below its all time high reached in March 2000, many high-profile market analysts, including Jeremy Grantham of GMO and Cliff Asness from AQR Capital, are pessimistic. They claim that profits are at a cyclical peak and that a low dividend yield will generate poor future returns for stocks.

Yet I believe the opposite is true and think that the current valuation of the stock market is very favorable for investors. Before explaining why, let me respond to these bears.

The quote above is from Jeremy Siegel, the finance professor from Wharton. He goes on to explain that he's bullish on stocks for two reasons. First, the current earnings yield (the inverse of the price/earnings ratio) is quite a bit above current bond yields and are therefore attractive to long term investors. Second, he makes an arguement for an expansion in P/E multiples, which is less convincing in my mind. I am more pessimistic about interest rates and therefore more pessimistic about P/E expansion.

Friday, May 04, 2007

Fortune on Kurzweil

Fortune magazine has an article this issue on Ray Kurzweil, my favorite inventor/futurist. He has a great track record on predicting future technological events. He invented the flat bed scanner, the electric piano, speech recognition software; he has started 10 companies and sold 5; he's written five books; he has a computer science degree from MIT; he predicted that a computer would beat the world chess champ by 1998 (it happened in 1997) and he predicted the rise of a worldwide computer network back in the 80s. The fact that I'm writing this to be posted on the internet is testament to his vision.

He's now working on a computer managed hedge fund, among other things. The man is a little weird (he takes about 200 pills a day; vitamins, anti-oxidants, etc.) but he shouldn't be written off as some nut. Read the article.

Thursday, May 03, 2007

Skeptical Public

Via the Marketbeat blog at the WSJ, the American Association of Individual Investors reports that 54% of the respondents in it's weekly poll believe the market will decline. And that, very simply, is why I am still bullish.

Economy Re-Accelerating?

There has been much angst about the housing market and its potential effect on the economy, but recent data may indicate that the economy is re-accelerating. Jobless claims, which had been rising, are now falling again. Weekly claims fell to 305,000 last week; anything under about 350,000 is usually associated with a growing job market. In addition, the ISM surveys are rebounding. The manufacturing survey rebounded to 54.7 in April and the non manufacturing survey, released this morning, rose to 56. Both figures were better than expected and a number over 50 indicates expansion. Lastly, the productivity and employment cost numbers released this morning were also better than expected. The mid cycle slowdown may be ending.

Obviously, that is good news, but it may also mean that the likelihood of a Fed rate cut is approaching nil. The Fed meets next week and I do not expect any changes in the rate or the statement that accompanies the announcement. The Fed is still more worried about inflation than growth, as they should be. I haven't been in the rate cut camp anyway, but it will be interesting to see how the lower rate/better growth dynamic plays out in the market. I suspect better growth will give comfort to the recesssion worrying crowd and that could give us another push higher in stock prices.

Tuesday, May 01, 2007

Flat Tax World

Daniel J. Mitchell, of the Cato Institute, argues at that tax competition is coming to a country near you:

The world has changed. Today, spurred by tax competition, there are now 16 jurisdictions that have some form of flat tax, and two more nations are about to join the club. With the exception of Iceland and Mauritius, all of the new flat tax nations are former Soviet Republics or former Soviet Bloc nations. This is a sign of tax competition in the region, and shows that people who suffered under communism are less susceptible to class-warfare rhetoric about “taxing the rich.”

Tax competition works the same way competition always works; it makes the participants more efficient. Governments have been mostly immune to competition, primarily due to closed borders and immigration limitations. But with the internet and the formation of the EU, those impediments are less onerous. Workers and companies can migrate to jurisdictions with favorable tax climates - and they do.

Moral Aspects of Trade

Alex Tabarrok has a good post on the morality of free trade at Marginal Revolution:

Peter wishes to trade with Jose. The individualist says the relevant moral community is Peter and Jose and presumptively no one else. Trade, the right of association, is a human right and on issues of rights the moral community is the individual. When Jose offers Peter a better deal than Joe it's wrong - a moral outrage - for Joe to prevent Jose at gun point from trading with Peter.

The more common view expressed implicitly by Dani Rodrik, but by many others as well, is the nationalist view, the moral community is Peter and Joe. Joe gets a vote on Peter's trades. Peter should be allowed to trade only if both Peter and Joe benefit, otherwise too bad. Jose counts for less.

A third view, that of the liberal internationalist, says that Peter, Jose and Joe count equally and are together the moral community.

I can easily fit into either the individualist or liberal interationalist camps. Lines on a map shouldn't have anything to do with trade. And free trade increases the wealth of the world as a liberal internationalist would claim.

Mobile Europeans

Things are changing in Europe as I detailed in my recent Tactical Update. Tax rates are falling and deregulation is no doubt coming as well. Anne Applebaum at the Washington Post has an article about Nicolas Sarkozy, the front runner in this weekends French election. Apparently he wants all those Frenchmen who've fled to the friendlier economic climate of the UK to come home:

The British capital was, he said, a "town that seems more and more prosperous and dynamic every time I come here." More important, it had become "one of the great French cities." He understood, furthermore, that hundreds of thousands of Frenchmen had moved to Britain because "they are risk-takers, and risk is a bad word" in France. With distinctly un-English passion (some things never change) he pleaded with them:

"Come home, because together we will make France a great country where everything will be possible, where fathers won't fear for the future of their children, and where everyone will be able to make their plans come true, and be responsible for their own destiny."

The EU has ushered in the mobile European, who goes where the jobs are rather than waiting for the government to do something for them. This bodes ill for high tax, high regulation countries like France. Sarkozy has run on making changes to the French economic system; it'll be interesting to see how successful he is if elected. His opponent, Royal, is gaining a little in the polls.

Lusking Eviscerates Lou Dobbs

Donald Luskin rips Lou Dobbs a new one at National Review On Line:

Last month, when Dobbs testified before Congress, it was not just a case of preaching to the choir, or even the blind leading the stupid. It was vivid proof of Goethe’s famous dictum, “Nothing is more terrible than ignorance in action.”

Let’s take a look close look at Dobbs’s testimony. It was long on impressive-sounding claims based on apparently authoritative statistics. But virtually every seeming fact that Dobbs cited is flat wrong.

And finally:

A cavalcade of error and statistical misrepresentation was the best the superstar of the protectionist movement could do. When it comes to the facts, Dobbs ought to consider a more liberal personal trade policy. If he wants the truth, he’ll have to import it from someplace else. He’s fresh out.

I have said here many times that protectionism is the greatest threat to our prosperity. Lou Dobbs is a dangerous man and one would think CNN would want him to use actual facts rather than his made up ones. Politicians only need small encouragment to do the wrong thing and Lou Dobbs gives them a big audience. Why exactly was Lou Dobbs testifying before Congress about trade anyway? They couldn't find anyone more qualified?

Tactical Update

I've posted my most recent Tactical Update on our website. Click on the title of this post to read the whole thing:

The DJIA rose above 13,000 today (4/25/07). The correction of late February is but a distant memory as investors cheer --- what? The economic picture hasn’t changed much in the last month; indeed if anything the slowdown may be starting to gain some traction. So why are stocks rising?

It has been said that when the US economy catches a cold, the rest of the world gets the flu. Is that still true? I believe there are some fundamental changes happening to the world economy that have significant implications for our investments. The globalization process continues apace regardless of the wishes of our provincial politicians. The news that no one seems to want to report is that globalization is working as advertised. The process makes the world economy less volatile as faster growing foreign developed and emerging economies offset the weakness in the US. Furthermore, there seems to be a smoothing effect on US corporate earnings as well.

You can also check out my Active Tactical Portfolio here.

What They Don't Tell You

Steve Antler at Econopundit, who has recently returned to blogging, has a post that puts the recent dollar weakness into perspective. In short, the fall in the dollar doesn't seem so bad when viewed in the proper context:

WHAT THEY TELL YOU: The dollar dropped to an all-time low against the euro after the U.S. government reported the economy grew at its slowest pace in four years.

WHAT THEY DON'T TELL YOU: The dollar's been around for quite a while. On the dollar-historical scale, the euro was invented last week. "All time" highs or lows aren't really very interesting under these circumstances. Similarly, "slowest pace in four (count them -- 4!) years isn't that interesting either (except as a scary headline).

WHAT THEY TELL YOU: The dollar also weakened against most other major currencies, with the Federal Reserve's Trade Weighted Major Currency Dollar index at its lowest level in its 36-year history. The U.S. currency pared its losses against the euro after touching the record low and triggering buy orders.

WHAT THEY DON'T TELL YOU: First, read this carefully. The dollar dipped below its historic low briefly, then came back up.

In my recent Tactical Update, I touched on this, but Antler puts it into a longer term perspective. I am not much worried about the dollar and frankly with everyone else worried about it, I probably don't need to. I am beginning to wonder if we aren't in for some kind of major counter trend rally in the dollar. With everyone else bearish, maybe it would pay to be a little bullish.

Antler also points out that this is nothing new with the dollar:

Oopsies! Bloomberg forgot to point out there was a much bigger runup of the dollar's value in the 1980's, and a much bigger dollar crash between 1985-1988!

STILL MORE THEY DON'T TELL YOU: The consequences of run ups in the dollar index have been deteriorating current account trade balances. The consequences of occasional dollar "crashes" have been improvements in the current account trade balance (a.k.a. more domestic jobs)....In short: we've been here before, only much worse, and actually everything came out okay.

Supreme Court Supports Innovation

WASHINGTON: The U.S. Supreme Court, in its most important patent ruling in years, has raised the bar for obtaining patents on new products that combine elements of pre-existing inventions.

If the combination results from nothing more than "ordinary innovation" and "does no more than yield predictable results," the court said Monday in a unanimous opinion, it is not entitled to the exclusive rights that patent protection conveys. "Were it otherwise," Justice Anthony Kennedy wrote in the opinion, "patents might stifle, rather than promote, the progress of useful arts."

This ruling by the Supreme Court should start to put an end to the patent trolls who stifle innovation by accumumlating dubious patents and then litigating, or threatening to litigate, against anyone who even comes close to violating their "patent". These trolls are typified by companies like NTP which sued Research in Motion (maker of the Blackberry) and forced a $600 million settlement. In most of these cases the patent trolls merely add obvious enhancements to existing products and claim a new patent. This stifles innovation and slows development of new products.

Many libertarians are against patents in general, but I tend to think that granting patents in cases of truly novel inventions does stimulate the creative process. The patent period of 20 years may be too long, but there seems little doubt that the incentive of a monopoly for a granted patent has produced positive results. How many would take the risks of invention if as soon as it is produced, others could just replicate the product? Then all products become merely a matter of becoming the most efficient producer.