Paging Dr. Bernanke

Since Fed Head Bernanke announced Quantitative Easing III (QE3) last week, I have been reading as much analysis about it as possible.  It is another in a series of bold steps to triage the patient.

But, first, quantitative easing occurs when the Fed Reserve buys bonds.  By accepting the bonds, the Fed then credits the checking account of whomever sold them the bonds.  In this case, the seller (U.S. Treasury) now has cash to spend.  That's how you finance a deficit.  It also provides a demand for bonds that did not otherwise exist, and, as everybody knows, if you increase demand for something, the price usually rises.  When the price of bonds increase, that means the yield goes down, since the interest rate is fixed.

Previously, when the U.S. Treasury sold bonds to finance its deficit, there were always plenty of buyers in the marketplace for those bonds.  Then, the Treasury started selling more than the market wanted.  In addition, the Chinese announced they had a bellyful and would increase their holdings of Treasury bonds much more slowly.  (Since they own over a trillion dollars of our bonds, that is probably enough, I think.)

To sell all these new bonds, when the demand is decreasing, the market would normally demand higher interest to be paid.  That would have increased the burden of interest expense for taxpayers and raised the borrowing cost for private debt, such as bank loans and mortgages.  Rising interest rates may be great for savers but awful for an economic recovery.

Does quantitative easing increase the Money Supply?  Theoretically, QE would not increase the money supply if the Fed "sterilized" its purchases, which means they sell a bond every time they buy one.  As a practical matter, I believe it absolutely does increase the Money Supply.

Is that inflationary?  Theoretically, it would not be inflationary if the Fed is agile in decreasing the money supply once the economic recovery becomes permanent.  As a practical matter, I believe it is absolutely inflationary.

Most analysts characterize QE as a "sugar-high."  All that new liquidity washes over the capital markets driving up the stock market.  When people see their 401Ks increase in value, they will feel more wealthy and spend more money, which is critical for a sustainable recovery.  Economists call this the "wealth effect."

It must be working because the stock market has rebounded much more than the economy has.  Maybe, that is because the new money created is not getting into the economy.  It is stuck in the capital markets, providing the "sugar-high."

Other analysts characterize the  Fed's action as a dope-dealer supplying drug-addicts on Wall Street.  The expectation is that there would be no other reason to buy stocks in the face of such a weak economy, which is struggling under the wet blankets of (1) the European financial crisis, (2) the elections, and (3) the fiscal cliff.

My perspective is that the Fed is a good, kind doctor, who is injecting large quantities of both blood and painkillers into one arm of a patient, while a grizzly bear gnaws lazily on the other arm.  Economic policy consists of monetary policy, controlled by the Fed, AND fiscal policy, controlled by Congress.  Both arms are essential to protect the body and fight recession.

As long as Congress is more protective of their political parties than the country, fiscal policy is useless, reducing economic policy to a one-armed fighter.  But, what happens when Dr. Bernanke runs out of blood plasma and painkillers? 

Springtime in Europe

This Spring, things were improving rapidly in Europe.  The ECB had instituted its Long-Term Refinancing Operation (LTRO) program that essentially gave banks a new three-year funding mechanism or three year "lease-on-life."  Interest rates started falling.  Their stock markets were rising.  Optimism bloomed!

Then, it all fell apart . . .

This Fall, things are again improving rapidly in Europe.  The German Supreme Court didn't kill the European Stability Mechanism (ESM).  The European Commission has asked the ECB to supervise all European banks, which is another loss of sovereignty by each member.  The ECB has said it would start buying bonds of member nations, a type of quantitative easing.  Dutch voters approved more political integration.  Their stock markets are all up.  Optimism is blooming again.

And, I expect it will all fall apart again . . .

Nowhere is the problem of entitlements being addressed!  The debt of these nations reflects their level of entitlements.  Even Greece, who was the first country to enter the crisis, has barely touched their level of entitlements.  It took them a full year before they fired one single government employee.

To an economist, the problem is clear.  Entitlements must decline and discretionary spending must decline and taxes rise in some combination.  Eliminating discretionary spending like infrastructure in order to maintain entitlement spending is counter-productive, just as eliminating discretionary spending in order to maintain tax breaks are also counter-productive.

Entitlements are like herpes -- once you have it, you have it always, unfortunately.

So, I don't believe all the optimism blooming in Europe.  We've seen this movie before.

The Most Important Person In The World

On Wednesday, the most important person in the world will be Andreas Vosskuhle.  He is the head of the German Supreme Court, which will rule on the constitutionality of German support for the European Stability Mechanism (ESM).  It is widely believed that the court will support it, which is one of the three legs critically necessary to deal with the European financial crisis.  If the court rules it unconstitutional, the bears will start eating Europe quickly . . . as in tomorrow.

On Thursday, the most important person in the world will be Ben Bernanke.  He is head of the U.S. Federal Reserve system, who will announce the results of their latest meeting.  It is widely expected that he will announce another round of quantitative easing (QE3), which will weaken the dollar and drive up the price of commodities like oil and gold.  If he does not, the bears will be growling on Wall Street.

On Friday, all will return to normal when Angela Merkel is again the most important person in the world.  She is the head of Germany, of course.  Europe cannot recover without her, but she is besieged by her fellow Germans who insist it is better to let the Eurozone break apart -- than to spend the money necessary to save it.  With an occasional day off, she will remain the most important person in the world . . . at least until January 20, 2013.

For The Really Bored

http://www.usabooknews.com/jimflinchum.html 

The Wrong Rand Book

Now that Paul Ryan has received the Republican nomination for Vice-President, there is a resurgence of interest in the writings of Ayn Rand.  The hero in her books is always an intense, self-confident, self-made man who fights over-whelming odds to remain true to his beliefs.

Ryan required his staff to read her book Atlas Shrugged, which describes how John Galt organizes a secret army of entrepreneurs seeking to avoid efforts to crush them by the central government.  This paranoia about government energizes and drives the Tea Party.  It is understandable that a refugee from the Communist revolution, like Ayn Rand, would be so focused on this possibility.  It is also understandable that such a story would resonate so strongly in a nation proud of having fought for its independence.

However, there is much to be learned from her other books.  In Fountainhead, the hero is Howard Roark, who is a brilliant architect that insists on designing buildings differently.  The architectural "establishment" and builders condemn him for championing a design that nobody likes.  Mr. Roark loses all his clients and is forced to become a common laborer but NEVER stops insisting he is right.  (Of course, he prevails in the end.)

In other words, Mr. Roark was not persecuted by government but was persecuted by his peers for not conforming.  Perhaps, that takes even more courage.  It is certainly more lonely.

Ben Bernanke could have refused to exercise his power as Chairman of the Federal Reserve system to make monetary policy responsive to a rapidly weakening economy in 2008.  He could have conformed to the wisdom of central bankers everywhere -- that good monetary policy cannot fix bad fiscal policy or that bankers cannot fix what elected politicians do wrong.  Bernanke argued that this is certainly true in the long-run, but monetary policy can buy enough time for slower-moving politicians to fix their mess in the short-run.  It also demonstrates a certain faith in the political process.  He behaved like Howard Roark in Fountainhead, standing up to his peers.

Mario Draghi is Chairman of the European Central Bank, the central banker of Europe.  He is clearly following the lead of activist central-banker Bernanke.  He has committed himself to saving Europe.  Like the Tea Party here that believes Bernanke is the problem, the Germans and Finns claim Draghi also doesn't have the power or authority to save anybody.  Like Bernanke here, Draghi has said "not on my watch" will there be a full-blown depression.  I wish him well.

The world economy was healthy when Bernanke moved desperately to prevent a depression here.  However, the world economy is not healthy enough now to survive a real depression in Europe.  A European collapse would more likely cause a global collapse.

I lose no sleep worrying about Federal storm-troopers swooping down in black helicopters, not in a nation of 310 million people with 440 million guns.  I do lose sleep worrying that I won't see freighters passing my home, going in and out of the harbor, that I won't hear airplanes landing at the Norfolk airport, that we have a global depression.

Bernanke and Draghi behave like Howard Roark.  They rail against the wind, against the conventional wisdom.  In the end, Roark was redeemed, as I believe Bernanke and Draghi will be.

Jogging Resolution

While jogging through Seashore State Park yesterday morning, I was listening to talk radio and heard the disc jockey say he had to get to bed by 9PM in order to do his 6AM show and had missed Obama's speech the  night before.  Then, the conservative DJ and Romney-supporter added "but I heard it was a good one."

A few minutes later, an irate listener called in, complaining he shouldn't say that without also saying something bad about the speech.  Fumbling briefly, the DJ asked rhetorically if he could not repeat what somebody told him and was told by the irate caller he had an obligation to "badmouth bad people."

After an uncharacteristic silence, the annoyed DJ said -- he promised long ago never to badmouth his ex-wife and, if he was not obligated to badmouth her, then he was not obligated to badmouth anybody else.

Missing the point, the caller then insisted that Obama was going to surrender control of our military to the U.N. immediately after the election.  Realizing the caller was definitely a kook, the DJ said "I don't like you, but I'm not going to badmouth you either.  I'm just going to . . ."  Then, there was a dial tone.

That testy exchange on the radio forced me to make a resolution.  Therefore:  Be it resolved that I will not speak negatively of any person running for office, including Obama and Romney.  It serves no purpose and cheapens anything else I might have to say.  I wish the politicians and their handlers would do the same.

Now, about that ex-wife . . .
  

The Bad News and The Good News

When is good news really bad news?  The unemployment rate just dropped from 8.3% to 8.1% of the workforce.  That must be good news?  Nope!

The latest monthly Jobs Report, prepared by the Department of Labor, was issued this morning.  Economists were expecting about 125 thousand new jobs to be created last month.  Instead, it was only 96 thousand.  Once again, economists merely laugh at their embarrassment. 

The reason that the unemployment rate fell is that the workforce shrank.  368 thousand people gave up last month.  They're not receiving any unemployment benefits.  They're no longer part of the workforce, making the total workforce smaller -- small enough that the unemployment rate of that workforce actually decreased.  And, they're NOT laughing at their embarrassment.

In fact, the labor force participation rate or the percentage of working-age people who are actively working  (full-time & part-time) plus those looking for work has dropped to barely 65%, which is a 30-year-low.  That means one-out-of-three working age Americans is a student, a homemaker, or a drop-out.  That's historic.  What is the value of the work those people NOT doing?

I have an old friend who was a high-flying marketing executive until he lost his job in Atlanta over three years ago.  Since then, he has lost his house.  His family has left him.  He got a minimum-wage retail job for awhile but lost it.  I suspect he lost that job because he started drinking heavily.  I lost contact with him and, about a month ago, called his parents.  They have also lost contact with him and are worried to death about him.  They're not laughing either.  I didn't know what to say, other than I'm sure he'll show up . . . I hope!   

I assume he is out-of-the-workforce, that he is no longer "participating" and is no longer counted.  I suspect he feels like he no longer counts at all.  I'm confident he is not laughing.

Despite all the numbers issued by the DOL each month, they don't tell the full story of our lousy unemployment market.  It is more than a mere political football.  How will we re-integrate millions of people back into the workforce who have lost their jobs, their identify, and their self-esteem?  They sound like damaged goods to me, almost some type of economic PTSD.  I wouldn't hire them, who would?

So, what's the good news?  No matter how bad it is, it could always be worse?  That is right, isn't it? 

A New Tool In The Toolbox

Understandably, economists are always asked about the economy.  We rely on our training, and our experience, while trying to be mindful of our philosophical leanings between the Austrian, the Keynesian, and Supply-side schools of economics.

Some try to avoid the discussion by relying on "technical analysis," which means lots of charts and spooky terms like "double-inverted head & shoulders."  My thinking is that technical analysis is just an interesting way to avoid thinking.

Some months ago, I ran across a quote from Oliver Wendell Holmes.  He said  . . . "When I want to understand what is happening today, I try to decide what will happen tomorrow;  I look back; a page of history is worth a volume of logic."

As a lover of all-things Williamsburg and a proud graduate of William & Mary, his statement resonated with me.  I promptly shifted my reading program more toward history, reading such books as The Panic of 1907 and Manias, Panics, and Crashes.  While reading history is an important part of making predictions, it provides mostly anecdotal lessons and is more useful in predicting the economy than predicting the stock market, which is more quantitative or numbers-driven.

If you look at the stock market as a system of mathematical relationships over time, computers should be able to help make sense of that history. Finally, some bright, young guys from M.I.T. are making significant strides.  Their company name is Hidden Levers, which implies that non-obvious connections can impact each particular portfolio differently.  It is a massive multiple regression analysis between 14,000 stocks and 15,000 mutual funds and 130 economic indicators, requiring literally millions of computations everyday.

As an example, the program tells me that a particular client's portfolio will go down 8.1% if Congress takes us over the Fiscal Cliff.  That doesn't mean I believe it will go down 8.1%.  It tells me the obvious, of course -- that it will go down.  It also tells me that the mathematical probability is that it will go down somewhere between 5% and 10%.  It tells me how vulnerable this particular portfolio is, compared to all other portfolios I manage.  It even tells me some suggested changes I could make now to prevent that loss later.  It tells me a lot!

Will any computer ever predict the future?  No, not precisely!
Will any computer ever be able to predict "black swan" events?  Not a chance!
Will any computer replace human judgment?  No sane computer should even try!
Will any computer make me a better financial advisor?  I think so!
Will any computer improve investment management?  Of course, it already has!

For now, I have a bright, shiny new tool in my toolbox, and I like it!

BTW on Labor Day

From my window on Labor Day, I can see many Americans enjoying the beach.  Meanwhile in Europe, the leader of Germany has finished hiking the Alps, and the leader of France has returned from the Rivera to cobble together enough agreement to end their financial crisis.  At least, I hope so . . . it's only been three years since this crisis began!

Thursday will be an important meeting of the European Central Bank (ECB), when they may announce their own quantitative easing or buying the bonds of weak nations, in order to hold down their borrowing costs.  Next week, the German "Supreme Court" will rule on the constitutionality of the European Stability Mechanism (ESM).  (There will be much consternation if it is declared unconstitutional, which will make the Euro drop, the dollar rise, and gold to fall.)  The following week, all the European Finance Ministers will meet to debate the recommendation to give pieces of their sovereignty to the European Commission, which should be interesting.  I think the European financial crisis is coming to a head over the next 60 days, which means the stock market could be quite volatile during this period.

Domestically, this Friday is one of two days that might determine the presidential election.  They are  September 7th and October 5th.  On those days, the Department of Labor will issue their monthly "jobs report."  IF anybody in this country has not already decided how they will vote, they might be strongly influenced by this information.

Just remember, as you hear Republicans and Democrats warn of how bad America will be -- if the other side wins -- that it could be worse . . . you could be going back to work in Europe . . . or even worse, looking for work  in Europe -- where unemployment is 11.3% (25.1% in Spain)!

So, ignore the American politicians -- you already know how you will vote!  Instead, keep your attention on Europe . . . 

Thank Goodness for Ava Gardner

There was an informal survey of financial advisors on CNBC yesterday, showing an over-whelming 68% of us think the most important event this year will be the November election.  I guess all those financial advisors watched the Republican Convention last week and are looking forward to the Democratic Convention this week . . . not me.

I plan to watch the exact amount of the Democratic Convention as I did the Republican Convention, which was zero, zilch, or none-at-all.

Nobody ever called any political convention a "no-spin zone."  They are giant, glossy infomercials, with a complete anti-intellectual bias.  Indeed, even face-to-face debates are mere contests in which candidate can remember the most applause lines, as pre-determined by focus groups.  It is pre-packaged spontaneity.

All suffer from the conceit that David Brooks described in his excellent column last week, i.e., they talk as if they will govern without the existence of the other party.  Why bother to listen to that?  The possibility does not even exist.   It would be an alternative reality.

Last week, I was fortunate to watch two old, classic Ava Gardner movies (Night of the Iguana and 55 Days at Peking) during the Convention coverage.  Let's hope the Turner Classic Movies channel will be as good next week.

I am among the 19% of financial advisors who believe the most important event of the year will be the European financial crisis.  While little has happened over the summer, as expected, the little that did happen was quite positive.  There is reason to believe that this September and October could be the critical months, when we finally achieve some clarity, if not resolution.  However, if we do get a clear resolution in the near future, I expect to get bullish again quickly.

My expectation about the November election is that it might alter the degree of gridlock but not end it.  My expectation about the Fiscal Cliff is that the elected Congressional cowards, who care more about their re-election than their country, will once again vote to "kick the can down the road" by simply changing the effective date to the following year.

So next week, I'll be looking for the remote control again.  Besides, what man wouldn't prefer looking at Ava Gardner instead of Romney or Obama?

The Joy of Cartoons

So, who is the all-important swing voter listening to ??

Generational Baggage

It's hard not to think of particular individuals when reading a book about people.  I've been reading The New Retirementality by Mitch Anthony, and it is a "must-read" for Baby-Boomers.  It reminds me of the many, many Baby-Boomers I have talked with, who are bitter and disappointed that they will not enjoy the retirement their parents did.  Their parents were usually more frugal but still spent enough to enjoy life.  More importantly, their parents benefited from the times they lived in.  Baby-Boomers feel they have failed personally, when they were really just misled by The Greatest Generation, who lead them to believe a good retirement comes to those who work hard.

For most of mankind's history, we just got old and died.  Hopefully, we worked to pull our weight until the date of death.  In the early 1900s, sociologists and business academics began writing that workers over the age of  40 (yes, forty) were actual burdens on productivity and could slow down the production lines.  Age discrimination became commonplace, and workers were routinely fired if the production line slowed.

Fortunately, America was a young, growing nation of profitable companies who learned they could attract more-talented workers if they promised to treat the workers better when they got old.  For the rest of the workforce, the less-talented workers, they got what became known as Social Security.

Pension plans became commonplace, especially following World War II, which means they have been commonplace for only 70-75 years in the history of mankind.  Indeed, pension plans became more commonplace for The Greatest Generation but less commonplace for the Baby-Boomers.  Having lost the need for desperate frugality as children of The Greatest Generation, Baby-Boomers are painfully surprised to learn how important frugality was and how corrupted they have been by advertisements to consume.

The book goes on to build a solid case for changing a person's work skills so they can remain financially productive and useful throughout life.  I strongly recommend it to all Baby-Boomers!

But, throughout the book, I kept thinking about a particular lifelong friend, who is part of The Greatest Generation.  The ONLY thing he ever wanted to do in life was to NOT work.  Apparently, work is bad for people??  Fortunately, he got a job with the Federal government and retired at the tender age of 55.  He is now 89 and making more in retirement than he ever made when he was working.  He has been retired more years than he worked.  I would expect he would pat himself on the back for "beating the system" or getting a sweet deal.

Instead, he feels like a victim . . . because he worked at all.  Maybe, he remembers early sociologists who said a worker was "over-the-hill" at an early age.  Maybe, he remembers World War II, even though he never saw combat.  Maybe, he believed all the assumptions of Tom Brokaw's The Greatest Generation.  Or, maybe, he just had a depressive personality-type.  I don't know, but it is sad to see a person live so long with such good fortune and still feel sorry for himself.  As a boy, I was taught that "idle hands are the Devil's tools."  So is idle time, and I strongly believe that is a huge problem in retirement.

Read The New Retirementality, stop feeling like a failure, get off your butt, and make a plan!

Hitting the Snooze Button

During the past month or so, the previously-scary stock market has been pleasantly tranquil.  I expect it will remain that way another week or so.

In the meantime, the Fed holds its annual symposium in Jackson Hole, Wyoming.  This is an important meeting of central bankers worldwide (except ECB's Draghi).  It is very informal, with the most important conversations held in hallways and outdoors, viewing the majestic Grand Teton mountains.

Fed chief Bernanke will speak this Friday.  Two years ago, he announced the first quantitative easing program at this meeting.  While he is expected to announce another round of quantitative easing next month, he is not expected to say anything significant this Friday.  If he does say anything significant, the stock market is not likely to over-react as it usually does, because traders have cleared out for one last long weekend of vacation before the Fall season begins.

The Fed hates this time during the election cycle anyway.  Any action they take or don't take right before the election is considered "political."  They are indeed damned if they do and damned if they don't.

Next week, the Europeans begin returning from vacation, which is a far greater risk to our market.  There have been some hopeful signs, such as that Merkel has been urging other leaders to tone down their rhetoric and has been letting her Finance Minister take the lead.  Her approval numbers have increased, giving her a little more negotiating room.  But, in the end, Europeans will produce more drama than results, which drives the stock market crazy.  I expect significant downside risk over the next few months because of Europe.

Then, in case you forgot, there is a U.S. Presidential election.  I was hoping either party will win by a clear, foreseeable landslide.  However, as the election is apparently so tight, the stock market may go into election night with no idea of whether to buy or sell the next day.  Take comfort in the fact that the stock market is generally bullish during November and December of each Presidential election year.

That traditionally bullish close to the year may not happen this year, as we are approaching the dreaded Fiscal Cliff, when tax rates go up and government spending goes down.  I'm not as worried about that happening as before.  Only the Tea Party seems driven by principle to go over the cliff.  Both the Establishment Republicans and Democrats are willing to "kick the can down the road."

Maybe, the Tea Party is right?  Maybe, a 5% recession is worth it, in order to finally deal with the issues.  (The last one was a 6.4% recession.)  But, would the Tea Party be willing to negotiate even then, once we are over the Cliff?  If not, it would be worse than a 5% recession.

So, hit the snooze button and enjoy the end of summer . . . you'll need to be well-rested this Fall.

Romney's Real Religion ?

Ever since Ronald Reagan accepted the teachings of Arthur Laffer and became a born-again Supply-sider, Republicans have been required to genuflect on the altar of Supply-side economics, which believes that leaving money with the rich allows them to create jobs.

Since Romney is a member of the wealthy 1% and only paid 14% of his income in taxes, it is reasonable to assume he was also a true-believer of Supply-side economics.  Interesting, there is reason to suspect he may instead be a closet Austrian economist, who believes in balancing the budget even if it means tax increases for the rich.

His team has leaked that he is willing to cap the interest deduction on home mortgages for high-income earners.  This is tantamount to a tax increase.

He thinks the tax exemption for interest earned on municipal bonds needs to be reduced.  This is tantamount to a tax increase.

He wants to limit the exclusion from gross income for high-value executive employer-provided health insurance.  This is tantamount to a tax increase.

He even wants to end the exclusion for earnings on life insurance policies.  Again, this is tantamount to a tax increase.

Of course, all these tax increases could be offset by a decrease in the highest marginal tax rates, but it tells me that Romney might be willing to come out of the closet and actually balance the budget.  If so, he will be the first Republican since Reagan to actually do so.

I've got my fingers crossed . . .

The Gold Standard or Constitutional Discipline?

Largely as a result of Ron Paul's remarkable organizational abilities during the long Republican primary, the party platform will, for the first time in twenty years, advocate a return to the gold standard.  This strongly appeals to those who believe it will automatically limit spending.  As usual, it is more complicated.

America was on the gold standard until President Nixon took us off of it in 1971 during the first oil crisis.  At that time, an ounce of gold was slightly over $20 each.  Today, our money supply is roughly $2.56 TRILLION, and it is backed by only 262 million ounces of gold.  That means gold would soar to $10,000 per ounce, which would be one gigantic economic adjustment.  If you believe the Republican Party will actually do this, you should consider buying gold now.

To keep the arithmetic simple, let's assume the current market value of gold is $2,000 per ounce.  That means our money supply might be 400% too large for the amount of gold backing the dollar.  Shrinking our money supply that much and doing it suddenly will certainly cause another depression.

Returning to the gold standard would be an admission that elected politicians are incapable of making the hard decisions, and I would agree with that.

Another approach would be a balanced budget amendment to the Constitution, which is also an admission that elected politicians are incapable of making hard decisions, and I would agree with that again.

However, one of the main reasons that Nixon killed the gold standard over forty years ago was because his policy options were limited by it.  He was under political pressure to "do something" about the high levl of unemployment and wanted to engage in deficit spending.  (This is a Keynesian fiscal approach.)  He needed freedom to act, and the unemployed appreciated his actions.  Unfortunately, he made a long-term change to our financial system to fix a short-term problem.

A better approach would be the Austrian or "tough love" solution of requiring the budget to be balanced but, instead of being balanced every single year, over every four-year rolling period.  If you have a big deficit this year, it is fine to take a Keynesian approach and have deficit spending, but then you must produce enough surplus over the next three years to pay off the deficit.

Yes, there would be problems with implementing this solution, but it would still be far better than our current reliance on the elected children in Congress to make the hard decisions for us.

The Joy of Intelligent Voters

Readers know I divide the world of economics into three schools.  There is the Austrian or "Tough Love" school that argues a balanced budget is essential every year.  There is the Keynesian school that argues deficit spending is essential when the economy is weak.  Then, there is the Supply-side school that argues a cut in the highest marginal tax rate is always essential.  No one school is better or worse than the others.  Different situations demand different solutions.

Back during the dark ages of 2009, there was fear that the world financial system was bordering on collapse.  In the U.S., we enacted the $787 billion stimulus bill.  That was a Keynesian solution, which I supported, despite being an Austrian-at-heart.

In eastern Europe, there is the small (1.2 million people) nation of Estonia.  They took the Austrian approach of cutting spending AND raising taxes.  The government froze all pensions, cut salaries by 10%, and raised their value-added-tax a whopping 2%.  They did not borrow money to keep going.  In other words, they did not borrow money to pacify their people.  Their debt remained about 7% of GDP, compared to our debt level of approximately 100%.

Despite our stimulus bill, our GDP shrank 6%.  The Estonian GDP shrank a stunning 14% -- over twice as bad as ours.  Unemployment soared to a heart-breaking 16%!  The Estonian people suffered greatly . . .

Today, unemployment in Estonia is "only" 10.8% but dropping.  It is dropping because GDP is growing -- rapidly -- 7.5% last year (think China-like growth), compared to the U.S. rate of about 2%.  The Estonian people suffered greatly . . . but not for long!   They just ripped-off the scab!

When facing dire economic circumstances, the U.S. took a Keynesian approach of increasing debt.  Estonia took the Austrian approach of cutting spending AND raising taxes, rebuking the Supply-siders.  So, which is the right approach?

As always, it depends . . . it depends on how the populations will react.  Can you imagine the outcry if we froze all pensions, cut government salaries 10%, and raised taxes significantly?  The Estonia people accepted hardship stoically, which permitted their government to do the right thing.  I don't think anyone ever called Americans stoic.

Now, would you rather be President of the U.S. or Estonia?

An Expensively Sweet Subject

Recently, Mayor Bloomberg of New York City proposed a prohibition on sugar drinks larger than 32 ounces.  My first thought was . . . NANNY STATE - I don't need no government bureaucrat telling me what to eat or drink.  I still feel the same way.

Later, I read Mayor Bloomberg's reasoning that obesity was driving up his health care expenses, which he was trying to control.  As it is now, an irresponsible consumer of sugar (or alcohol or tobacco) becomes a burden on either the taxpayers or other policy holders or both.  Why should I pay the obesity-related healthcare costs for people who eat sugar carelessly?

On a short road trip this weekend, I was in a convenience store, standing in line behind a mother with two kids.  Those kids each wanted a 12-oz bottle of sugar water (Coke) plus a bag of some candy I never heard of.  In fact, they were insistent that they NEEDED the sugar water and candy, AND they NEEDED that particular type of sugar water and candy.

Even though it is considered cute in our culture to watch children put unhealthy foodstuffs into their mouth, this young mother didn't want to do it and suggested less unhealthy options to no avail.  As someone who had to stand in line next to the strident children, I was relieved when she finally relented and paid $3.71 to pacify the kids.  After all, anybody who has ever been in a car with two cranky, disappointed children knows that $3.71 is a small price to avoid it.

As I drove away, I suspected the kids wanted sugar because it tastes good, and society smiles at kids having it.  It was more interesting to me that they had strong feelings about the particular sugar drink and candy.  That  could come from long trial & error, which I doubt, or recommendations from their peers, which is possible, or from TV advertising, which is the most likely.

While Mayor Bloomberg is right to control his health care expenses, should he try to regulate behavior of adults or should he tax the advertisers of unhealthy foodstuffs and use that revenue to cover obesity-related healthcare costs?  (Certainly, that tax or increased cost to sugar sellers would be passed on to the consumer, making the product more expensive, but maybe that will also discourage buying it.)

Do we really expect the good intentions of a young mother to overcome the relentless carpet-bombing of TV commercials?  Is that fair to the young mother?  And, when she fails, why do taxpayers have to pay for the medical costs of her kids when they become obese and elderly?

The Bull Days of Summer

Readers know I've been increasing cash for the last few months, expecting possibly severe turbulence the rest of the year.  But, the market has been drifting upwards over the last six weeks.  Does that mean the bull has returned?  In a word . . . No!

I would be more likely to believe the bull had returned if trading volumes had increased.  That would suggest investors are returning to the market, but this is not the case.  The dog days of summer normally see little action, and this is no exception.  However, trading volumes are even low for the summertime, running about 40% below normal.  The retail investor is definitely staying out of the market.

In addition, a bull market is traditionally "confirmed" when the Dow Transportation Index also rises, which has not been the case this summer.  The theory is that the market will be rising if the economy is doing better, and we'll know that when trucks and trains are carrying more goods, which makes the Transportation Index rise.  Without that confirmation, the bull rally only looks temporary.

My perspective is that the U.S. stock market has been a one-trick pony all year, reacting only to news out of Europe, who is on "holiday" right now, thank goodness!  Once European politicians get back to their usual work of  accomplishing very little, I expect we'll get whip-sawed again.  (I was worried the crisis would erupt again on August 20th, if Greece didn't make their bond payments due that day, but it appears they have now raised enough money to postpone the crisis until September.)

During the fall season, the conventional wisdom is that the market will start rising when it believes Romney will win, but I expect the market will not start rising until it believes gridlock will end, i.e., if the Senate also goes Republican, which won't be known until the election itself.  We'll see. . .

In the meantime, just enjoy the warm afterglow of a bull during the dog days of summer.  Better yet, join the Europeans and go on vacation yourself!

First Guest Blogger

Most blogs allow for readers to post their comments and react to whatever the blogger wrote.  This blog does not permit that . . . and for a very good reason -- securities regulators are like traffic police, i.e., they are humor impaired.

If a client responded to something I wrote with a kind word, I would be in trouble with the regulators for allowing what they call a "testimonial."  Therefore, nobody is allowed to respond to this blog.  However, that doesn't stop clients from emailing me directly.

I received one yesterday that I thought was interesting and, with his permission, am doing a copy/paste of his email into this blog today.  (Because he doesn't mention me, I am permitted to publish it, but not his name.)  Therefore, please welcome our first guest blogger!

Decision

For years, I considered myself Independent.  I favored neither the ideology of the right or the left. I am very much toward the center.  I believed that there were good people on both sides and adjusted my vote accordingly.

Today, I tune out the rhetoric.  The TV ads are assigned to my internal SPAM folder.  Being results oriented, I look at what has happened.

In 2008 this country was bleeding jobs by the hundreds of thousand, home prices were in free-fall. 

Foreclosures were the headlines, and the country was bleeding money, as well as precious lives in two drawn-out wars.

Our foreign relations were in the tank, and our respect overseas was negative.

Starting three years ago, we began seeing positive employment figures.  Now we are often seeing hundreds of thousand of jobs being created every month.  IRA's, which tanked in 2009 with the DJIA at 6500, have now recovered with the DJIA above 13,000.  Three years ago, we saw home prices start to slow their drop.  Today, we read of home shortages, as well as increased home sales -- with home prices rising! Three years ago, our malls and highways were empty. Our entertainment destinations also. Not so today.

Today, our Government is respected throughout the world.  Our foreign policy is one of our strong points.  We have greatly reduced the financial drain by pulling out of Iraq and are now disengaging from Afghanistan.  Our exports are recovering nicely, especially compared to the rest of the world whose exports are decreasing.  Manufacturing jobs are returning to the United States. Amazingly, Honda is increasing production of vehicles in the United States for export!  We are becoming energy independent with new enormous oil and gas reserves and with an emerging alternate energy industry. Highways are jammed, destinations are very busy.

This is a remarkable recovery in four years. Particularly remarkable since the present administration has had to accomplish this against the continuous objections, roadblocks and active obstructions of the opposing party. Their Legislators have publicly stated, contrary to their oath of office, that their primary mission in the legislature is to deny the just elected President another term.  Result: greatly slower than necessary recovery.

No amount of rhetoric or false facts can refute the obvious. The choice is between the successful and the obstructionists.  I choose the Successful.

But, Everybody Else Is Doing It . . .

John Kenneth Galbraith was a famous Keynesian economist who wrote an influential book entitled The Affluent Society in 1958 and contributed a useful phrase to the American way of speaking -- "conventional wisdom."

It can refer to anything that is commonly accepted among others, kinda like saying "everybody else believes this is true, so don't bother me with any other facts."

According to "conventional wisdom," hedge funds produce the best investment results, and that the $2.1 trillion invested in hedge funds represent the "smart money."  Although the facts don't support that belief, I remain confident that belief will not change.

According to the Bloomberg Hedge Fund Index, which tracks almost 2,700 hedge funds, they have lost an average of 2.2% every year for the last five years, while the un-managed S&P 500 has gained 0.2% each year.

But, don't worry about the poor hedge fund managers, as their clients pay steep fees.  Normally, they are paid "2 & 20." which means they get 2% of the asset value each year plus 20% of any capital gains.  By comparison, a traditional investment advisor gets 1% each year and is prohibited in sharing in capital gains.  Investors must not mind paying such fees, since total hedge fund assets are up 300% from 2000.

Galbraith once said “There are those who don’t know and those whom don’t know that they don’t know. I say there are those who know they are in the game; there are those who don’t know they are in the game; and there are those who don’t know they are in the game and have become the game”.  Such is the fate of investors who willingly pay the high hedge fund fees.

Then, they brag about being a hedge fund investor . . . go figure?

The Romney-Rand/Ryan Ticket

I have a long-time love/hate relationship with Ayd Rand, who wrote many things, including the powerful Atlas Shrugged.  I believe I have read everything she ever wrote and have seen movies of several of her works.  As a writer, I respect and envy the clarity with which she writes.  As a writer, I understand why she colored her characters in such black & white terms of good & evil.  What scares me about her writing is the zealotry she inspires!  There are many wild-eyed radicals who also love Ayd Rand.

This morning, we learn that Paul Ryan will be Romney's nominee for Vice President.  I like "numbers" people who can listen to the stories that only numbers can tell.  I have appreciated Paul Ryan for his obsessive-compulsive focus on the necessity of cutting entitlements.  He is also a long-time devotee of Ayd Rand.

He once said  "I grew up reading Ayn Rand and it taught me quite a bit about who I am and what my value systems are, and what my beliefs are. It’s inspired me so much that it’s required reading in my office for all my interns and my staff."  (A few years later, he did tell Catholic bishops that he rejected the atheism that is a small part of Ayd Rand's philosophy.)

I have mixed emotions about his nomination.  He is an affable numbers guy, who serves his country well by focusing on the cancer that is entitlements.  As a fellow student of Ayd Rand, I appreciate his intellectual journey.  But, the zealotry of her followers still scares me.

Now, one of those followers could only be a heartbeat away from the most powerful position in the world.  That worries me . . .

The Cost of Being Civilized?

My first assignment as a graduate assistant years ago was to research and teach a class on a theory of motivation by Victor Vroom from the University of Michigan.  His theory was a giant step forward in the ability to "quantify" motivation.  Basically, it says my motivation to do something is a function of (1) how bad I want it to do it and (2) how strongly I believe my efforts to do it will be successful.  For example, I may really want to beat Tiger Woods in golf, but I don't think my efforts will be successful.  Therefore, I am not motivated to do something I really want.

One of last week's headlines really stuck with me and made me wonder if there is a third factor when a person is motivated to do something illegal.

The IRS admitted they paid out $5 BILLION last year to identity thieves, and they expect that loss to continue into the future.

Now, suppose I want to make a lot money easily and suppose I believe my efforts to get rich stealing someone's identity will be successful, then I am very motivated to do so, right?

However, what are the consequences of my actions?  Is there a third variable to be motivated to break the law?  Wouldn't severe jail time or even the death penalty reduce the relationship between the variables in Vroom's theory?  Shouldn't his theory be re-stated to say my motivation to do something is a function of (1) how bad I want to do it and (2) how strongly I believe my efforts to do it will be successful and (3) do I really believe there will be negative consequences to my efforts?

Apparently, identity thieves don't believe there will be negative consequences, which means we can continue to expect billions of dollars in additional losses each year.  I suspect that is a small down payment to the cost of being civilized.  Could we discourage identity thieves and other criminals with a few public executions?  Of course, but wouldn't we then be less civilized?

At what point does the cost of being civilized exceed the benefits of being civilized? 

"The Righteous Mind"

I enjoy watching Greta van Susteran on right-wing Fox News.  I enjoy watching Rachel Maddow on left-wing MSNBC.  And, I enjoy watching Fareed Zakaria on semi-centrist CNN.  When he recommended this book by Jonathon Haidt last week as "required reading," I decided I would read it.  Humorously, Haidt appeared on Zakaria's show this morning, after I went to the trouble of reading his book.

Sadly, much of the book is a scholarly exploration of moral values, structures, etc.  While important, cynical economists normally find the subject a bit "squishy" for them.  Toward the end, however, the book gets very interesting.

One thought stream is that people have a need for "belongingness" which explains our need for religions and political parties or tribes.  We simply need to belong.  He cites another scholar with saying "it is religious belongingness that matters for neighborliness, not religious believing."

Philosopher John Stuart Mill said liberals and conservatives need each other, saying "A party of order or stability, and a party of progress or reform, are both necessary elements of a healthy state of political life."  Yet, it seems we have drifted back to the third century Persian prophet, Mani, who preached the world is either black or white, either good or bad, and you must choose.  Haidt tells us "if you think about politics in a Manichaean way, then compromise is a sin.  God and the devil don't issue many bipartisan announcements".

He explains the political parties have become too pure.  Today, the most liberal Republican is still far more conservative than the most conservative Democrat.  The number of voters describing themselves as moderates dropped from 40% in 2000 to 36% in 2011.  (I suspect the percentage is still dropping.)

We are less likely to see members of a different party or tribe than before.  In 1976, only 27% of us lived in communities where the incumbent Republican or Democrat won by more than 20 points, called "landslide counties."  By 2008, 48% of us lived in such communities.  In other words, Republicans don't see or talk with as many Democrats as they used to, and vice versa.  We have become more segregated, not by race but by political parties.  (Undoubtedly, some of this is also due to re-districting into safe legislative districts, but that was not discussed by Haidt.)

Big business knows this, of course.  Did you know that 62% of the counties that had a Cracker Barrel restaurant voted for John McCain, while 89% of those counties with a Whole Foods grocery store voted for Barack Obama in the last Presidential election.

I think Haidt's thesis is this:  we start with a slight gene bias about defensiveness.  Some small kids are more alert to possible danger than other kids.  Some kids are more open to new experiences than other kids.  The safety-loving kids have a slightly greater probability of becoming Republicans, while the experience-loving youngsters have a slightly greater probability of becoming Democrats.  Of course, many things later in life can alter the trajectory, but there does seem to be some genetic predisposition.

Haidt also believes that conservatives understand liberals better than liberals understand conservatives, because liberals hear conservative principles such as loyalty and authority as mere code-words for a police-state or, even worse, a theocracy.  In addition, liberal writings are more plentiful than conservative writings, making liberals less informed about conservative thought.  Liberals are less likely to "get it" or understand the point because they "over-think" it.

He cites one seemingly innocent suggestion of Newt Gingrich in 1995 as a major contributor to the vileness that is Congress today, when he urged the newly-elected Congressmen to leave their families at home, so they could save on living expenses.  That effectively precluded the traditional cross-party friendships that has served our nation so well for over two centuries.

The book ends poignantly with a political cartoon of a father and mother sitting in a living room, having a serious discussion with their young son.  The father explains to the boy "your mother and I are separating because I want what's best for the country and your mother doesn't."

Yes, America, we are that divided . . . and it is getting worse.

Something For Everybody

Everybody must have been happy yesterday, because the Dow rose 217 points, to the highest level in 3 months.

The Republicans were happy because they could lament the fact that unemployment rose from 8.2% to 8.3%  More significantly, the combination of unemployed plus under-employed (called the U-6 rate) rose to a scary 15%.  The Democrats were happy because 163 thousand jobs were created, far more than the 100 thousand jobs that were expected, albeit far fewer than the 250 thousand jobs needed each month.

But, that rate of job recovery following a recession is an interesting question.  Everybody knows this has been a slow recovery.  Now, take a look at this graph:

The blue dotted line shows the average rate of job recovery from recessions from 1954 to 2000.  The gold dotted line shows the rate of recovery from 2000 recession, which was minor by historical standards.  Lastly, the red line shows the current recovery rate in this recession.

There is no mistaking that the current recovery is S-L-O-W . . . but it is actually a tad better than the last recovery.  Generally speaking, recovery from a financial crisis does take longer than an ordinary recession, but that doesn't explain the similarity to the last recovery, which was indeed an ordinary recession.  (Don't you remember all the criticism President George W. Bush received about "the jobless recovery?")

One other number really struck me in yesterday's report:  3.5 million jobs are available in manufacturing but remain unfilled . . . because of a "mis-match in skill levels."  With over 14 million people either unemployed or under-employed, we cannot seem to find 3.5 million with the right skills.  There is something else holding back job creation, besides the fact we are recovering from a financial crisis.  Could it be that, in this post-computer revolution era, it will always take longer to recover the jobs lost -- because job skills are changing so rapidly from manual-to-computer-based-to-robotics??

In addition, is something happening in our manufacturing base that we need so many more workers?  Take a look at our "capacity utilization" or how much our factories are working, which looks like this:

This chart tells us that our factories are approaching 80% utilization, which is considered near-full capacity.  Above that level, cost-push inflation usually appears.  Now, imagine how that red line would perk up if we were suddenly able to fill those 3.5 million job openings in manufacturing.

That is just one reason why I believe our economy, the U.S. economy, is spring-loaded to grow once we get the two wet blankets known as Europe and the Election off of us.

Europe could easily produce another financial crisis at any time, and the Election could determine whether we go over the Fiscal Cliff, which could easily produce a fiscal crisis like we have never seen.

It is a time for politicians on both continents to be heroic . . . but not investors.  

It is time for the unemployed to borrow money from their families to get re-trained and then re-locate away from those families to wherever the jobs are.  (It sounds so easy when you don't need a job, doesn't it?)

Philosophical Consistency or Political Expediency

As a boy, I was taught that gentlemen don't discuss politics.  As a candidate in Army OCS, I was instructed never to engage in partisan activities, especially anything controversial.  Not surprisingly, I still avoid all things Republican or Democrat.  And, most of all, I RUN from any discussion of abortion politics!

Imagine then my consternation at a recent dinner party when I was seated next to a lady who wanted everybody else to know that she was very "pro-life" and even bragged that she had yellow license plates that read "choose life."  She was being very, very supportive of Republican Governor McDonnell for the new law that all women seeking an abortion must receive a briefing on the obvious horror of that procedure.  My dinner partner opined "I think women deserve to know the facts."

Avoiding the discussion as always, I just ordered another drink.

Yesterday, I listened to a webinar on the economic and financial planning considerations of ObamaCare.  There was an interesting discussion around the biggest "waste" in Medicare, which is spending huge sums of money on dying patients.  The speaker, who is both a physician and a financial planner, pointed out that the original version required that doctors inform the dying patients about the high cost of making extraordinary efforts to keep them alive -- when there was no hope anyway.  Predictably, the other political party promptly labeled such efforts as "death panels," and that quickly killed the debate.

I wonder if my dinner partner would have opined "I think dying patients deserve to know the facts?"

Don't terminal patients deserve facts as much as women seeking abortions?  

If the objective is to make abortion more difficult as well as to fight unpopular legislation, such as ObamaCare, then philosophical consistency is not necessary . . . or, is it?

So, which is worse:  An abortion or borrowing $100 thousand from the Chinese to keep grandma alive another month, which the next generation has to re-pay?

Before you answer that, better order another round of drinks for us all . . .