Beginning of the End for the Private Equity Party?

The WSJ has a front page article today about the difficulty KKR is having placing equity with outside investors in it's takeover of First Data. This would seem to indicate that the market for private equity deals is starting to saturate:

As Wall Street digests a feast of buyout deals announced during the past few months, one especially active buyout giant, Kohlberg Kravis Roberts & Co., is finding they don't all go down easy.

KKR has tapped out some of the traditional investors it might typically turn to in funding large transactions, setting it on a different course in the $26 billion acquisition of First Data Corp., a processor of electronic payments. People familiar with the matter say the deal isn't in jeopardy, but in its search for new partners in the acquisition, KKR finds itself haggling over terms it once could dictate.

Apparently some of their traditional investors are getting wary of putting more money with KKR:

"We have enough exposure to KKR already," says an executive at one major investor who invests money in private-equity firms on behalf of a variety of pension funds, endowments and wealthy families. "We have concentration limits with the private-equity firms and with KKR, we have reached the limit."

With interest rates rising, making borrowing more expensive for these types of deals, and now apparently some difficulty raising equity money, the beginning of the end of the private equity boom may be in sight. Maybe the Chinese will get in right at the top; just as the Japanese did before them in the 80s.

Cash for Grades

Since my daughter started high school, I've paid her for grades each term. The system works like this; an A gets her a $50 credit, a B is neutral, a C gets her a $50 debit. We don't even discuss anything below that, but in theory it would offset all credits for the term. The results have been more than satisfactory; her GPA is well over 4.0 when you take into account Advanced Placement classes. Even unweighted, here GPA is over 3.5. And that is a significant improvement over middle school where she routinely brought home mostly Bs mixed in with a couple Cs each term. I know, I know; I didn't really have anything to complain about with her performance. She had a choice of three fine magnet schools. But I wanted to see if I could improve the performance through economic incentives. While she disagrees with me, I think it has had an impact.

Now, a Harvard economist is trying to start the same experiment in some public schools:

Roland G. Fryer, a 30-year-old Harvard economist known for his study of racial inequality in schools, is back in New York to again promote a big idea: Pay students cash for high scores on standardized tests and their performance might improve. And he has captured the attention of Schools Chancellor Joel I. Klein and Mayor Michael R. Bloomberg.

Those against it have a familiar complaint that I've heard:

But the idea is controversial. Many educators maintain, among other objections, that children have to learn for the love of it, not for cash.

The way I look at it, my daughter's job is to attend school and learn. The problem is that the payoff for that is so far in the future that it isn't much of an incentive. So I filled that gap and gave her some more immediate incentives.

It'll be interesting to see if this is adopted and if it works. I suspect that those paying will find that it costs them a lot, but that they will enjoy it as much as I have.

Back to the Future Again

A few days ago, in a post titled Robbing Peter to Pay Paul, I said:

I think those who worry about the poor rising up and causing problems because of inequality of income are worrying about the wrong thing. What happens when the rich finally tire of paying the tab?

Well, it seems this is already happening in Europe:

Wealth gap grows and solidarity fades as rebellion of rich spreads across EU

That's a headline from the UK Guardian and it's not really a fair depiction of what I was referring to, but I think the principle is the same. The article is more about the rich regions of Europe who are upset about subsidizing the poorer parts. Northern Italy produces more wealth than Southern Italy and the northerners are pretty ticked about sending their tax dollars south. Or folks from Munich are tired of paying the freight for eastern Germans.

I find it disturbing that a large percentage of the US population wants to emulate the "European Social Model" when it is clearly not working very well. We just debated an immigration bill that would have made our policies closer to Europe's even though Europe is facing major problems because of that policy. The problem, on closer inspection though, is not the immigration policy. I favor a more liberal immigration policy in the US. I believe immigrants are enormously important to our economy and should be embraced. But only if we also maintain a liberal economic policy. And I don't mean liberal in the usual American sense, but in the classical economic sense. Low taxes, free trade, minimal government interference in the market and access to capital are critical if we are to liberalize our immigration policy. Otherwise, we will find ourselves in the same boat as our friends across the pond. A generous welfare state, rigid employment policies and high taxes mixed with open immigration resulted in a large part of the Paris suburbs in flames. Certainly, economic policy has consequences in the social arena.



Besides, the French are now trying to change the system by electing Sarkozy and now electing his party to Parliament in a landslide:

PARIS, June 10 — President Nicolas Sarkozy’s center-right camp was on course to win a landslide victory in Parliament today after the first round of France’s legislative elections, cementing his power to implement reforms in Europe’s third-largest economy.

I am not prepared to praise Sarkozy on economic policy yet, as he hasn't accomplished anything and it wouldn't be surprising if he bails on reform when the strikers hit the rue. But at least he seems to recognize the problem. Economic policy is the key to solving the problems of the Muslim immigrants in the Paris suburbs. Let's hope our politicians don't repeat the same mistakes as the Europeans.

SPR?

The United States has a Stragegic Petroleum Reserve that is intended to be used in the case of a supply disruption. China also has an SPR, but it's a different commodity:

The crisis over pork prices in China, like the jolt many Americans feel when gasoline prices jump, offers one example of how prices can suddenly soar. The Chinese government is struggling to cope — including deliberating whether to sell a snuffling, smelly strategic reserve of hundreds of thousands of live pigs kept at special subsidized farms for precisely the shortage the country is now facing.

Hmmmmm....Strategic Pig Reserve?

WiTricity

This is pretty cool too:

Scientists have sounded the death knell for the plug and power lead.

In a breakthrough that sounds like something out of Star Trek, they have discovered a way of 'beaming' power across a room into a light bulb, mobile phone or laptop computer without wires or cables.

In the first successful trial of its kind, the team was able to illuminate a 60-watt light bulb 7ft away.

It works on the well known concept of electromagnetic induction:

Rather than sending power from a transmitter to a receiver as a conventional electromagnetic wave - the same form of radiation as light, radio waves and microwaves - he could use the transmitter to fill a room with a 'non-radiative' electromagnetic field.

Most objects in the room - such as people, desks and carpets - would be unaffected by the electromagnetic field. But any objects designed to resonate with the electromagnetic field would absorb the energy.

I love it when we find new ways to apply old concepts. Human ingenuity is limitless.

New British Sub

Via Drudge:

The first of the UK's new generation of nuclear-powered attack submarines has been unveiled in Cumbria by the Duchess of Cornwall.

Due to enter service in 2009, BAE Systems' Astute is the most advanced submarine of its kind and comes bristling with the very latest in military technology.

BAE said: "With a radar signature equivalent to a dolphin, it can remain undetected thousands of miles from home and hundreds of metres underwater.

"In the right conditions it can detect the QE2 leaving New York harbour from the English Channel."

As some of you know, I spent some time in the US Submarine service. I enjoyed my time there, but we never had anything like this. Pretty damn cool.

Robbing Peter to Pay Paul

Bastiat said that the essence of government is to rob Peter to pay Paul. Someone also once said that a politician who robs Peter to pay Paul can always rely on the support of Paul. Democrats seem to have taken that to heart:

House Democrats looking to spare millions of middle-class families from the expensive bite of the alternative minimum tax are considering adding a surcharge of 4 percent or more to the tax bills of the nation's wealthiest households.

Under one version of the proposal, about 1 million families would be hit with a 4.3 percent surtax on income over $500,000, which would raise enough money to permit Congress to abolish the alternative minimum tax for millions of households earning less than $250,000 a year, according to Democratic aides and others familiar with the plan.

The AMT was a bad idea when it was introduced and it is still a bad idea, but why should one set of citizens be forced to pay the tab for another set? So much has been written about income inequality in this country and the consequences. I think those who worry about the poor rising up and causing problems because of inequality of income are worrying about the wrong thing. What happens when the rich finally tire of paying the tab? Who will Democrats tax when the rich finally get fed up? Who will the Democrats tax when they've taxed away the wealth?

Bretton Woods II

Randall Forsyth writes the Up an Down Wall Street column for Barron's during the week (and sometimes in the weekly issue as well). Today his column is about the potential unraveling of the so called Bretton Woods II currency arrangement.

IS BRETTON WOODS II heading for the same fate as its predecessor?

Bretton Woods is shorthand for the postwar international monetary system, named for the New Hampshire resort town where its blueprints were laid out by the Allies in the latter days of World War II. The rules called for currencies' exchange rates to be fixed against the dollar, whose value in gold was set at $35 an ounce.

Bretton Woods broke down essentially because our government couldn't decide between guns (Vietnam) and butter (the Great Society). Foreign governments eventually cut off the credit and Nixon removed the last vestiges of the gold standard from the US monetary system. The result was a decade in the economic wilderness known as the 1970s. Dollar collapse, high inflation, gas lines, etc.

Now some believe that the informal system in place since the Asian crisis back in 1998 is also coming unglued.

Central banks have been forced to step into the breach, buying the dollars needed to fund the U.S. current-account deficit, which is equal to about 7% of gross domestic product. In other words, America spends $1.07 for every dollar it earns. Foreign central banks lend us the difference, a form of vendor financing for all those goods produced abroad, especially oil.

In the process, China has accumulated $1.2 trillion of foreign-exchange reserves. Rather than keep piling up Treasuries ad infinitum, China will invest $3 billion of that in Blackstone, which sounds like a lot but equals 0.25% of its reserves.

Less well-publicized is that central banks are just saying "No" to piling up greenbacks. Not selling, mind you, as the disaster-movie scenario envisions; just accumulating at a slower rate.

There are signs that's beginning to happen, as the Bridgewater duo detail. In just the latest, this week Syria became the second Middle Eastern nation to abandon its currency's peg to the dollar, which followed a similar move by Kuwait last month. Meanwhile, a parade of countries has directed an increasing portion of their reserves away from dollars and euros. Among them, the United Arab Emirates, Switzerland, plus America's good friends, Venezuela and Russia. And China announced this week said it, too, will increase the euro's share of its currency cache -- not reducing dollars, but not adding to them as much.

This is the nightmare scenario for US financial markets. If foreign central banks won't take dollars, we've got a big problem. The result would probably be a collapse of the dollar and inflation a la the 1970s. A recession would also be quite likely; a very nasty recession. I don't believe that this will happen because frankly it is not in the best interests of these foreign central banks for it to happen. But if it does.....look out below.

Citigroup Settles

Citigroup Global Markets Inc. agreed to pay $15.2 million to settle charges that a team of financial advisers misled more than 200 BellSouth employees.

The Citigroup Inc. unit, which includes brokerage firm Smith Barney, will pay $3 million to settle the allegations by the National Association of Securities Dealers. The firm will also pay $12.2 million in restitution to the former employees at BellSouth, now a unit of AT&T Inc.

The NASD suspended three brokers and two branch managers, fining them a total of $295,000. Neither the firm nor the employees admitted or denied the charges.

The NASD said Citigroup failed to adequately supervise financial advisers who used misleading sales materials in dozens of seminars in which they promised 12% annual returns. Although the NASD alleged violations of its rules on just and equitable trade principles, it didn't file fraud charges.

Okay, let's review this again; if it sounds too good to be true....well you know the end of that statement. Brokers are not acting in your best interests; they are acting in their own best interests. Get an investment advisor who doesn't sell financial products. Period.

Saudis in Control?

Jim Juback's latest article on MSN Money asserts that the Saudis are in control of the US economy due to their status as the swing producer in OPEC:

Saudi Arabia is running the U.S. economy.

I'm not sure the Saudis want the task, but they've got it. Because the United States still doesn't have a national energy policy, we've thrown decisions about how fast our economy grows and whether our standard of living rises or falls into the hands of Saudi Arabia's oil ministry.

Yes, it's the lack of a national energy policy that allows the Saudis to exert this control over our economy. I would politely suggest that the reason we are so dependent on the Saudis is that we have tried to enact a national energy policy in the past. Every time the government has gotten involved in energy policy over the years - and that is disturbingly frequent regardless of Mr. Juback's yearning for more - it has made matters worse.

Energy policy is not the only area where Mr. Juback seems to yearn for the good old days of central economic planning:

Remember the good ol' days? Back when the U.S. Federal Reserve and its chairman were in charge of our economy? The Fed would try to find a delicate balance in setting interest rates: High enough to control inflation and low enough to encourage economic growth. Once upon a time, those policy changes were actually the most important decisions anyone made about the U.S. economy.

Yeah, that's the ticket! Let's get government employees back in charge of the US economy. If someone is going to exert control over the economy, let's make sure they are US government bureaucrats. The reason this attempt at control always fails is revealed in Juback's own words. "The Fed would try to find a delicate balance in setting interest rates: High enough to control inflation and low enough to encourage economic growth." The key word in that sentence is "try". The Fed can no better "find" the right price for interest rates than the Soviets could the price of toilet paper. In case Mr. Juback hasn't heard, markets are much better at setting prices.

Furthermore, Mr. Juback doesn't seem to get the connection between excessive liquidity, oil prices and oil demand. In one paragraph, he laments the Fed's lack of control due to excess liquidity:

By the Fed's own admission, the growth of global liquidity has reduced the U.S. central bank's ability to control interest rates -- and thus the economy -- in the United States. Think about this: The Fed raises short-term interest rates relentlessly from their 1% low in June 2003, and yet long-term rates sink as global cash flows overwhelm the Fed's domestic policy shifts.

Then he opines that rising global demand is what gives the Saudis some of their control:

One source of Saudi Arabia's economic clout lies in the galloping global -- and U.S. -- demand for oil. The U.S. Energy Information Administration forecasts that total world demand for petroleum will reach 118 million barrels a day in 2030, up from 83 million barrels a day in 2004.

Okay, let's see if we can figure this out. The Fed prints too many dollars. Those dollars are accumulated by the Chinese which causes the Chinese to print too many Yuan in an effort to maintain their exchange rate. The excess Yuan creation causes overinvestment and excess consumption in China which creates excess demand for oil from Saudi Arabia. And somehow that is the source of the Saudis power over our economy. Maybe, just maybe, if the Fed would quit flooding the world with dollars, some of that excess demand would go away. And we wouldn't have to depend on the good graces of the Saudis to maintain our standard of living.

According to Mr. Juback, this situation is set to get worse too:

I have bad news for anybody who thinks that this Saudi control over the U.S. and global economies is a brief phase that will end by itself. The decision among oil producers such as Saudi Arabia to shift away from being a mere producer of crude oil to becoming a producer of value-added products made from oil -- such as gasoline, fertilizer and plastics -- will prolong the economic clout of these countries. Saudi Arabia will go from being the low-cost swing producer of crude oil to being the low-cost dominant producer in gasoline, fertilizer and plastics.

All I can say is Thank God some nation wants to build refineries. Certainly, it is unlikely to happen in the US where environmentalist and their government enablers have succeeded in blocking any effort to build them here. Mr. Juback continues the article by talking about the cost advantages the Saudis have:

The cost advantages that Saudi Arabia brings to the game are huge. Methane and ethane, key feed stocks for petrochemical production, cost about 75 cents per million BTU in Saudi Arabia and $7.50 per million BTU (for methane) on New York commodity markets. Within five or 10 years, new industries now being built in Saudi Arabia are likely to soak up cheap natural-gas-feed stocks such as these.

Well the US has some pretty big natural gas fields too. There are trillions of cubic feet of natural gas lying just offshore. Oh never mind, the environmetalists won't let us drill for that either.

Apparently, the only way for us to regain some control is to conserve and use alternative fuels:

On the other hand, if higher prices lead to less consumption because consumers become permanently more efficient in the ways they use energy, and because consuming economies adopt lasting sources of alternative supply (and don't abandon them at the next dip in oil prices), then consuming countries have a chance to take back some degree of control over their own economies.

Well, here is my national energy policy. Drill for more oil and natural gas in the US. Then drill for more oil and gas in the outer continental shelf of the US. Build some nuclear power plants. Build some refineries. Then if we really want to get radical, enact a carbon tax. That will reduce demand for fossil fuels while also making alternative fuels more competitive. Last and most important, reduce the power of the Federal Reserve. In fact, eliminate the Federal Reserve. And someone tell Alan Greenspan to just please shut up.

Service Sector Outperforms in May

Business activity in the non-manufacturing sector increased at a faster rate in May 2007, say the nation's purchasing and supply executives in the latest Non-Manufacturing ISM Report On Business®.

The report was issued today by Anthony Nieves, C.P.M., CFPM, chair of the Institute for Supply Management™ Non-Manufacturing Business Survey Committee; and senior vice president — supply management for Hilton Hotels Corporation. "Non-manufacturing business activity increased for the 50th consecutive month in May," Nieves said. He added, "Business Activity, New Orders and Employment increased at a faster rate in May than in April. The Prices Index increased this month to 66.4 percent. Twelve non-manufacturing industries reported increased activity in May. Members' comments in May are mostly positive about business conditions. There is continued concern with rising fuel costs. The overall indication in May is continued economic growth in the non-manufacturing sector at a faster pace than in April."

The overall index, employment index, and the new orders index were all better than expected. The employment index confirms the recent drop in unemployment claims. It appears that the economy is recovering from the first quarter slump. We have contended for some time that the housing slowdown would not cause a recession and the economic stats are now starting to bear that out.

Manufacturing Continues to Struggle

The factory orders report released today confirms that manufacturing sector continues to struggle-

New orders for manufactured goods in April, up five of the last six months, increased $1.3 billion or 0.3 percent to $418.0 billion, the U.S. Census Bureau reported today. This followed a 4.1 percent March increase. Shipments, up two consecutive months, increased $3.4 billion or 0.8 percent to $412.7 billion. This followed a 2.1 percent March increase. Unfilled orders, up twenty-three of the last twenty-four months, increased $13.0 billion or 1.8 percent to $719.1 billion. This was at the highest level since the series was first stated on a NAICS basis in 1992 and followed a 1.8 percent March increase. The unfilled orders-to-shipments ratio was 4.85, up from 4.80 in March. Inventories, up thirteen of the last fourteen months, increased $2.4 billion or 0.5 percent to $513.5 billion. This was at the highest level since the series began and followed a 0.2 percent March increase. The inventories-to-shipments ratio was 1.24, down from 1.25 in March.

In a sign that business spending may be picking up, durable goods orders in April were up 1.9%. Inventories rose for the 14th consecutive month.

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.

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.

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.

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.

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.

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.

Flat Tax World

Daniel J. Mitchell, of the Cato Institute, argues at American.com 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.

Cool A/C

Toronto has found a unique way to take advantage of its location on Lake Ontario:

GEOTHERMAL heating—using the warmth of the Earth’s interior to heat water—is an old idea. Using the planet’s natural coolness, though, is something of a novelty. Nevertheless, as cooling and heating are merely two ends of the same process, it could save money and reduce carbon-dioxide emissions. As long, that is, as you can find a suitable source of cold.

Fortunately for Toronto, it sits next to a very large supply of the stuff, in the form of Lake Ontario. Canada’s largest city has been pioneering the idea that instead of using electricity to power air conditioning, a useful supply of cold can be directly extracted from the environment.

The amount of electriciy saved is significant:

Some 36 buildings in the central business district have now been connected and a further sixteen have signed on to join the system. The project is expected to save the city 61 megawatts, enough to power 8,500 homes.

Toronto is not the only place this works, but one has to wonder why this hasn't been done in more places. The article states that several places have been looked at and rejected - Chicago and New York among them. In those cases, the water wasn't deep enough near shore and the cost of running pipes out to deep water was prohibitive. But certainly there are places this could be applied.

California Goes Solar

CALIFORNIA’S $3.3 billion solar initiative, championed by Arnold Schwarzenegger, the governor, is impressive. State rebates, combined with federal tax credits, can cover up to half the cost of a residential solar system. California builders must now offer solar as an option on all new construction. Another perk: installing solar on existing buildings will not trigger a rise in California’s already heinous property taxes. Mr Schwarzenegger’s goal of a million solar roofs by 2017—in a state with 36m people, and growing—looks ambitious. It also looks relatively feasible.

The title of this post links to the story above in The Economist.

I am usually not a fan of government intervention and I'm not much worried about global warming, but I am a fan of solar power. I've been watching this industry for a long time and the efficiency of solar collectors is rising fast. See this story from last December about a solar panel that achieved a 40% efficiency in converting sunlight to electricity. Average panels today are in the range of 12-18%. That panel was developed using funds provided by the DOE.

Living in South Florida, I have wanted to install solar panels, but I've been waiting for the efficiency to rise enough to make the cost worthwhile. I don't like government intervention in the market, but I have hope that they'll get this one right. In this case, I think I can overlook the malinvestment caused by the government subsidy. The idea of getting energy from a source that isn't found under the Middle Eastern version of the Hatfields and McCoys is enough to convince me that any market distortion is worth the cost.

What? Me? Worry?

Don Boudreux has an excellent post on the fear many Americans have about the large Chinese holdings of US Treasuries.

Is there real reason for Americans to worry about the Chinese government buying and accumulating lots of dollar-denominated assets?

Probably not.

Like Professor Boudreaux, I do not worry much about the Chinese doing something that will hurt them as much, or more, than it will hurt America. Read the entire post by clicking on the title of this post.

Random Walker

Burton Malkiel, the author of A Random Walk Down Wall Street has a very interesting editorial in the WSJ today. The article is primarily about the reduction of risk premiums in financial assets:

The facts are that stock prices are high not only in the U.S. but also in the world's developed and emerging markets. We can estimate long-run annual equity returns by adding today's dividend yield (just under 2%) to the likely future growth rate of earnings and dividends (perhaps 5.5%). This calculation suggests that stocks are priced to produce about 7.5% future returns, well below the 10.5% annual returns achieved from 1926 through 2006. Treasury bond yields (at just under 4.75%) are historically low, as is core inflation, running close to 2%. The prospective equity risk premium (the amount by which stock returns are likely to exceed bond returns) of about two and three-quarter percentage points appears to be well below the five percentage point equity risk premium earned since 1926. We are not being paid as much to take on the risk of holding stocks.

Not only are equity premiums low; so are bond risk premiums. The spread between high-yield bonds (more pejoratively called junk bonds) and safe U.S. Treasuries is just about at an all-time low. Sovereign emerging-market debt yields are not much more than two percentage points over U.S. government debt. The VIX index, measuring expected U.S. stock market volatility, is extraordinarily low. These measures imply that financial markets are very relaxed about risk and that the world is a very stable place.

This is something I've touched on before and I agree with Mr. Malkiel. He goes on to say that there may be reasons why the markets are not pricing in as much risk as in the past. The reduced volatility of economies in general and the subsequent reduction in the volatility of earnings may mean that stocks and other financial assets are priced correctly. And as an efficient market believer (one place we part company) he is reluctant to believe that markets are mispriced. However, he also states:

I believe that markets are high and risk spreads compressed because of massive increases in world liquidity. A world awash in dollar-based purchasing power has helped to keep our interest rates low and the spreads on risk assets tight.

This, to me, seems inconsistent with his stated belief in efficient markets. If the world is "awash" in liquidity, doesn't that imply that there is something wrong in the system? Doesn't it imply that the central bankers of the world are doing something wrong? And doesn't that imply that assets are mispriced because of the distortions caused by the central bankers?

Mr. Malkiel ultimately gives some good advice though:

So what should investors do as the Dow rises to new highs? Should they "sell in May and go away," as one stock-market bromide suggests? As a student of markets for over 50 years, I am convinced that attempting to time the market is a fool's game. But new highs in the market should induce investors to review their asset allocations. If the rising stock market has pushed your allocation of equities well above the level consistent with your risk tolerances, it makes sense to consider rebalancing. Rebalancing is an excellent strategy to constrain your investment risk in a very uncertain world.

We are always evaluating exposure to the various markets we cover so rebalancing in our tactical portfolios is something that happens regularly, but our investment models are all based on static portfolios with regular rebalancing, generally 2 years. Rebalancing generally forces investors to sell some of what has gone up and buy some of what has not. Sell high, buy low. Good advice.

Falling Dollar = Inflation

Another WSJ article highlights the link between a weak dollar and inflation:

Overall import inflation has moderated because oil prices aren't rising as fast as they did a couple of years ago. But other signs of import inflation are out there. In March, prices for imported consumer goods, excluding automobiles, were 1.8% higher than they were a year earlier -- the biggest gain in 11 years, points out Morgan Stanley economist Richard Berner. The risk is that this could make it harder for the Fed to cut rates in the presence of economic weakness. Calling it stagflation -- the coupling of economic weakness and skyrocketing prices -- is overdoing it, but there's a whiff of it in the air.

However, there are some positive effects as well:

Last Friday, the Commerce Department reported that gross domestic product grew at its slowest pace in four years in the first quarter. The Dow Jones Industrial Average advanced, nonetheless, as it has most days in a month that's so far seen it add 767 points.

The big factor in the rally has been that, thanks to the combination of strong growth overseas and a weak dollar, overseas sales have pushed profits higher at many companies. Among the companies whose first-quarter strength has come as a surprise to investors: Whirlpool, 3M, Caterpillar and Coca-Cola.

It is this effect that has been the source of my bullishness on large cap stocks over the last six months. That is starting to pay off now. Smaller companies are more dependent on the domestic economy while the big multinationals benefit at least as much from strong overseas economies.

This is a Problem?

The WSJ has an article about a conundrum facing the Bank of Japan. The Japanese economy is expanding but deflation remains persistent (prices are falling again). Apparently this is viewed as a problem:

Still, such weakness in prices would make it difficult for the Bank of Japan to raise interest rates. Raising interest rates too quickly could discourage consumers and businesses from spending, depressing demand and putting more downward pressure on prices.

Oh my goodness, the economy is expanding, prices are falling and the central bank may have to keep interest rates low, whatever will we do? Can the government please rescue the Japanese citizen from these terrible conditions?

Wii Hacking or Why the Video Game Industry is Important

The WSJ has an article about the Wii-mote, the remote control for Nintendo's Wii video game console. Apparently hackers are reprogramming the remote for other functions:

A deejay in the Netherlands uses his to mix techno music at dance parties. A medical student in Italy has reprogrammed his to help analyze the results of CT scans. And a Los Angeles software engineer has found a way to get his to help vacuum the floor. The high-tech device in each case: the remote control from a $250 videogame console.

With a Wii console, the Wii-mote is used to act out the video games. For instance, with a tennis game, you swing the remote to swing the racket on the video screen. The Wii-mote has an accelerometer that detects the speed and direction of motion. This is translated into action on the screen. I could make a comment sure to show my age about how lazy teenagers are today (Um, why don't they just go play tennis?), but I think the more important point is that because of a video game controller, innovation is happening. And not just innovative new ways dj:

Some companies see possible business applications with the Wii-mote. Rick Bullotta, vice-president of SAP Research, an arm of the German software giant SAP AG, is looking at ways to integrate the Wii-mote into their clients' manufacturing operations. He envisions factory and warehouse employees walking through facilities pointing and waving Wii-motes to monitor and control machines. "It's the first time we've used a videogame controller for R&D," he says.

Innovation begets innovation. It will be interesting to see how Nintendo reacts to this. It seems that so far, they've only issued some boilerplate statement saying the Wii-mote was created solely for use with the Wii console. Well, yeah, but somebody forgot to tell the hackers. Will Nintendo be so sanguine when someone reprograms the Wii-mote for a higher, more profitable use? I hope so. I don't know if there would be any patent issues at stake, but if there are, Nintindo should waive any rights to them. The new innovative uses of the Wii-mote is already benefiting Nintendo (you can buy the remote seperately from the console) and any new uses will likely benefit them more.

I'm sure many people don't think of the video game industry as anything important, but if part of a video game system can help analyze a CT scan, maybe you should reconsider that position.

Bubble World

Jeremy Grantham is a legendary value investor with a gold plated client list. According to this article in The Street.com, he believes the world is in a bubble:

Everything is in bubble territory, he says.

Everything. "From Indian antiquities to modern Chinese art," he wrote in a letter to clients this week following a six-week world tour, "from land in Panama to Mayfair; from forestry, infrastructure and the junkiest bonds to mundane blue chips; it's bubble time!"

"Everyone, everywhere is reinforcing one another," he wrote. "Wherever you travel you will hear it confirmed that 'they don't make any more land,' and that 'with these growth rates and low interest rates, equity markets must keep rising,' and 'private equity will continue to drive the markets.' "

I don't know anything about Indian antiquities or modern Chinese art, but in many ways, I agree with Mr. Grantham. The world is awash in liquidity and many risk assets are trading at unreasonable valuations. I don't think that applies to US stocks, but emerging market bonds and emerging market stocks certainly fall in that category. I just don't think the bubble is ready to burst just yet.

Abolish the Federal Reserve

As long time readers know, I have no love for the Federal Reserve. When you give a bank the monopoly on printing money, well, that's what they will do. That the Federal Reserve's official policy is to maintain an inflation rate says a lot about the purpose of the bank. Our government issues debt and the Federal Reserve creates excess currency to inflate away the value of the debt. A little like the fox guarding the hen house if you ask me.

I believe that the only way we will ever have really good economic policy in the US is to abolish the Fed or move to a gold standard (which really amounts to the same thing). Most people don't believe this is possible, probably because there has always been a Federal Reserve during their lifetime. But there is one country that has no central bank and it's operating just fine thanks:

In this modern, post-–Bretton Woods world of "monetary order" and coordinated central-bank inflation, many who are otherwise sympathetic to the arguments against central banks believe that the elimination of central banking is an unattainable, utopian dream.

For a real-world example of how a system of market-chosen monetary policy would work in the absence of a central bank, one need not look to the past; the example exists in present-day Central America, in the Republic of Panama, a country that has lived without a central bank since its independence, with a very successful and stable macroeconomic environment.

Just think: a world where Ben Bernanke is just an economics professor. What a wonderful thought....

Technorati

Technorati Profile

6% inflation

If you click on the title of this post you will be taken to John Williams' website, Shadow Government Statistics. Check out the chart that graces the top of the page. The chart shows what reported CPI would be if it were still calculated as it was prior to the Clinton administration. If you're having trouble reading it or you don't want to really see it, I'll tell you the number is 6.2%. That's right 6.2% annual CPI inflation. Anyone have a guess as to how the market would react if everyone knew that number was the truth rather than the 2.8% figure recently reported by the government?

Technology to the Rescue

Consider energy. We are awash in energy (10,000 times more than required to meet all our needs falls on Earth) but we are not very good at capturing it. That will change with the full nanotechnology-based assembly of macro objects at the nano scale, controlled by massively parallel information processes, which will be feasible within twenty years. Even though our energy needs are projected to triple within that time, we'll capture that .0003 of the sunlight needed to meet our energy needs with no use of fossil fuels, using extremely inexpensive, highly efficient, lightweight, nano-engineered solar panels, and we'll store the energy in highly distributed (and therefore safe) nanotechnology-based fuel cells. Solar power is now providing 1 part in 1,000 of our needs, but that percentage is doubling every two years, which means multiplying by 1,000 in twenty years.

The peak oilers and other Malthusians will be wrong again. This is a quote from Ray Kurzweil who was the first to see the promise of the internet way back in the early 80s. He's been right so many times about future events, one wonders if he truly does have a crystal ball. I believe that technological advances will make the whole issue of peak oil and global warming a moot point withing the next 25 years. Check out Kurzweil's web site; it'll help you keep up to date with the advances that are happening at an increasing rate. http://www.kurzweilai.net/

Short Interest

Short interest on the NYSE hit another record last month. From a contrarian viewpoint, this is bullish. Sentiment is a major factor in our decision making process and short interest indicates widespread skepticism about the market.

Chutzpah

This story comes courtesy of Opinion Journal, the WSJ daily blog by James Taranto. Mark Mellman, writing in The Hill, opines that the Democrats have wrested control of the tax isssue from Republicans. As most of you know, I am a libertarian so I don't have much use for either of the major parties, but the one thing I've always sided with Republicans on is lower taxes. Here's what Mellman has to say:

While the taxman keeps coming, we now care a little bit less.

Everyone dreads April 15, but for decades, Republicans turned distaste for taxes into votes against Democrats. We were decried as the party of higher taxes, while Republicans championed Richard Nixon’s immortal slogan, “It is time to get big government off your back and out of your pocket.”

Races at all levels, at least sometimes, hinged on taxes, usually to the detriment of the Democrat. Almost every cycle, millions of dollars in ads attacked Democrats for supporting some tax or other. In 1946, Republicans developed an 18-point lead as the party better able to deal with taxes; Democrats lost 54 House seats, in part as a result. Though the question was asked only intermittently, Democrats maintained an edge as the party better able to deal with taxes through most of the rest of the ’50s and again in 1978, then through the early ’90s. However, in 1994, when the GOP opened a 10-point lead on taxes, disaster struck with Democrats again losing 54 house seats, partly as a result.

In the last couple of election cycles, though, the air has slowly, though not completely, seeped out of the tax balloon, as evolving public opinion has reduced the power of this standard GOP attack.

Gee, I wonder public opinion has shifted?

While no one wants to pay more taxes, the perceived burden has diminished. Earlier this month, 53 percent of respondents told Gallup the amount they paid in federal income tax was too high. Though still a majority, it represents a significant decline from the two-thirds who thought their taxes were too high in the late ’90s. In 1993, 67 percent of Americans told Harris they “had reached the breaking point on the amount of taxes they paid.” A decade later that figure dropped by 15 points. CBS found 49 percent saying they paid more than their fair share in 1997, but just 37 percent taking that position this month.

Why has the perceived burden of taxes diminished? Maybe it has something to do with the fact that the actual burden has diminished? What happened in that decade? Oh yeah, we had a tax cut that was opposed by almost every Democrat. Maybe that has something to do with Americans being less concerned about taxes?

Democrats will likely look at this and decide it's okay to raise taxes. They should look at it and worry that if they raise taxes, they'll start losing elections again.

ETFs Stray

The WSJ has an article this morning about ETFs which have diverged from the performance of the benchmarks they were designed to match. The funds cited most frequently are the funds that are designed to match the price of oil. A number of these funds have diverged widely from the actual price of oil. The technical reasons why this is happening is not important to us since we don't use these ETFs, but the problem could affect investors who are making narrow bets using ETFs. We use mostly broadbased ETFs which have not experienced these problems. Frankly, I think the ETF market is getting a little out of hand. The number of funds has exploded as sponsors try to slice and dice the market into ever smaller segments. The problem is that there is not suffcient trading volume to maintain the narrow spread between market price and NAV. Stick to the broad based ETFs and you shouldn't have any problems.

Lots of oil

Iraq could hold almost twice as much oil in its reserves as had been thought, according to the most comprehensive independent study of its resources since the US-led invasion in 2003.

The potential presence of a further 100bn barrels in the western desert highlights the opportunity for Iraq to be one of the world’s biggest oil suppliers, and its attractions for international oil companies – if the conflict in the country can be resolved.

This would not seem to be a good development for the price of oil. Of course, as this article from FT.com points out, the "conflict" in the country will have to be resolved before most of this oil sees the light of day.

So far the only new contracts for developments by foreign companies are the five signed by the Kurdistan regional government in the relatively peaceful north of Iraq.

The new supply seems significant:

The study from IHS, a consultancy, also estimates that Iraq’s production could be increased from its current rate of less than 2m barrels a day to 4m b/d within five years, if international investment begins to flow.

Adding 2m b/d to world supply would certainly have an effect. Considering as well that the only way this comes to market is if the violence in Iraq is greatly reduced, the potential drop in price could be significant. Maybe, just maybe, is it possible that Iran might want to prevent such a drop in price? And if that is true, what could they possibly do to make sure it doesn't happen? Hmmm, let me think. I know! They could try to stir up a civil war in Iraq!

Or maybe its just about bragging rights down at the Arab League?

If confirmed, it would raise Iraq from the world’s third largest source of oil reserves with 116bn barrels to second place, behind Saudi Arabia and overtaking Iran.

The Iranians will not help us stabilize Iraq. It's not in their best interests to stabilize Iraq. Their economy is already in a shambles; they can't afford a big drop in the price of oil. The mullahs very survival depends, at least in part, on maintaining a high price for oil.

Inconvenient Science

I haven't seen An Inconvenient Truth, Al Gore's global warming propaganda film. I don't usually get my science news and facts from politicians. The science of global warming, contrary to what Mr. Gore says, is not settled. There are many scientists who don't subscribe to the simplistic global warming model espoused by Gore and other alarmists. The fact is that there is still a lot we don't know about weather on this planet. And new things are being learned every day by scientists who are actually bothering to do research. For example, there is a new study from Lawrence Livermore National Lab about trees and their effect on climate. The conclusions are not what we have been taught by the environmental movement:

This chattering-class environmental picture is not necessarily wrong, but it does include many assumptions. One of them, that planting trees will make the world cooler than it would otherwise be, is the subject of a newly published study by Govindasamy Bala, of the Lawrence Livermore National Laboratory, in California, and his colleagues. Dr Bala has found, rather counter-intuitively, that removing all of the world's trees might actually cool the planet down. Conversely, adding trees everywhere might warm it up.

Now the scientists behind this study are not recommending that we cut down all the trees. Their point was merely that the environment and what affects it is a very complicated subject with few pat answers:

The reason for this is that trees affect the world's temperature by means other than the carbon they sequester. For instance forests, being generally green and bristly things, remain quite a dark shade even after a blizzard. They are certainly darker than grasslands smothered in snow, and thus they can absorb more of the sun's heat than vegetation which might otherwise cover the same stretch of land. That warms things up.

Transpiration—the process by which plants suck up groundwater and evaporate it into the atmosphere—is another and opposite matter. Woodlands are usually better than other ecosystems at getting water vapour into the air. In warm places this tends to make things cloudier, and those clouds, in turn, reflect the sun's heat back into space. That cools things down.

There is still a lot to learn about the climate on this planet. Until we have a better grasp on things, it makes no sense to allow politicians like Al Gore to decide how to address a problem that may not even exist.

Rational Healthcare Debate

There is a very good post over at the Economist blog, Free Exchange, about healthcare:

WHAT is it about healthcare that utterly short-circuits rudimentary economic knowlege? It is not that there are no good arguments for socialised medicine, mind you. But why is it that so many arguments in favour of nationalisation, even from certified economists, seem to rely on the notion that fundamental laws of economics have somehow been repealed in the case of health care?

I run into this all the time when trying to debate the healthcare issue. People are so fed up with the current system that they have decided that the only answer is to let the government handle things via a single payer system and they won't listen to any other alternative. There are free market economic answers to making our healthcare system function better. The problem with the debate at this point is that the general public believes we have a free market system and its failing. Nothing could be farther from the truth. The employer provided insurance system we have is itself a result of corporations attempting to avoid a government mandate (wage controls after WWII).

Just about 50% of healthcare in this country is currently paid for by the government. If the system is getting worse and this percentage is rising, it is illogical to believe that raising the percentage to 100% will make things better. It seems logical to me that the reverse would be true. Furthermore, I've dealt with government healthcare in the Navy and believe me, that is not a path we should take as a country.

Tax the Tall

I know most people who read this blog are not economic geeks like me, but I had to post something about Greg Mankiw's new econ paper at Harvard. Here's the abstract:

Should the income tax system include a tax credit for short taxpayers and a tax surcharge for tall ones? This paper shows that the standard utilitarian framework for tax policy analysis answers this question in the affirmative. This result has two possible interpretations. One interpretation is that individual attributes correlated with wages, such as height, should be considered more widely for determining tax liabilities. Alternatively , if policies such as a tax on height are rejected, then the standard utilitarian framework must in some way fail to capture our intuitive notions of distributive justice.

What's the conclusion? Well, I haven't finished reading it yet so I'll have to let you know, but so far this is the funniest serious economic paper I've ever read.

Tax Day Call for a Flat Tax

Deroy Murdoch chooses today, for obvious reasons, to call for a flat tax to replace our current system.

As kitchen tables nearly buckle beneath receipts, pay stubs, and calculators, Americans must be grateful that tax returns are due only annually. Today’s deadline reacquaints us with our humungous tax-filing burden. It also suggests a voluntary flat tax as the exit from this morass.

The flat tax has been adopted by a multitude of Eastern European countries with great effects. Even Russia has adopted the flat tax. When Russia has a simpler tax system than the US, I say it's time for reform. Me? I filed for an automatic extension yesterday.

More Pig and Gumbo Fest Pictures

More Pig and Gumbo Fest Pictures

More Pig and Gumbo Fest Pictures

More Pig and Gumbo Fest Pictures

Pig and Gumbo Fest Pictures

Pig and Gumbo Fest

This past Saturday, AIM had its first annual Pig and Gumbo Fest. We had 82 pounds of suckling pig, two huge pots of Gumbo, homemade bread pudding, home brewed AIM Ale and lots of nice people.

We believe that the key to our success as a company is to serve our clients. We don't work for a brokerage firm or mutual fund company; we work for our clients just as we did on Saturday. We didn't cater this affair; Orlando and I started pig preparations on Friday with a trip to Palacio de los Jugos, an institution in Miami, to purchase fresh sour oranges for the marinade. Salt, fresh garlic and oregano were added and the pig was marinated overnight. We arrived at the park at 7:30 Saturday morning to get the 82 pound monster in the Caja China.

Ralph, a Tulane grad who learned some useful skills while in New Orleans, prepared the roux for the gumbo Friday night and completed two batches of gumbo on site. He also made a batch of his famous bread pudding.

Julian and Ashton were in charge of logistics and thought of everything. Good job to everyone involved.

A special thanks to my wife, Fay, who braved the aisles of WalMart to buy most of the supplies.

I'll be posting pictures all day so check back often. All of you who couldn't attend missed a great time. See you next year.

What Correction?

The market made a new high for the year. All of the correction that started on February 27th has been recovered. That the market has recovered this quickly just demonstrates the strength of the market -- we are still bullish.

Chinese Takeout

Here's a more traditional defense of free trade as it relates to China:

Washington’s insistence on retaliating against China for undervaluing its currency, dumping cheap goods onto U.S. markets, and for subsidizing exports implies that China is an enemy to be retaliated against. But does anyone seriously believe that U.S. consumers are worse off if goods can be imported more cheaply than they can be produced at home? Imposing tariffs on China harms U.S. consumers and industrial users of imported products; it is an act of economic suicide.

Politicians are the greatest threat to our prosperity. Cutting off trade with China will have some serious consequences - for us.

Compare and Contrast Tiger Woods and China

Donald Luskin has an intersting take on all the China bashing:

A powerful and dangerous force has been unleashed on the global economy. It’s a new source of skilled labor that has put American workers at a competitive disadvantage — and no one knows just how many jobs have already been lost because of it. The U.S. is running a huge trade deficit with this force; every year we’re spending millions more on what it produces than it spends on American goods and services. And to top it all off, this entity has built a massive currency reserve, investing large sums of it on U.S. government securities and thus enabling America’s fiscal profligacy.

Why, oh why, won’t the U.S. government do something to protect us from . . . Tiger Woods?

The analogy isn't perfect but Luskin makes a good argument. Much of the anguish about China is akin to the Japan bashing we heard back in the 80s. I say if China is willing to send us actual goods in exchange for pieces of paper with pictures of Presidents, we should let them.