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