March 3, 2014

If You Build It, They Won’t Come: Opinion

Posted in business, Capital, cost of living, Economic Growth, Economy, Federal Reserve, generation, government, income gap, industrial economy, Inflation, investment advisor, investment banking, investments, job market, labor force, Labor Market, large business, medicare/medicaid, National Federation of Independent Business's, revenue, Robert Barone, small business, social media, social security, taxes, Unemployment, wages, Wall Street at 8:31 PM by Robert Barone

It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.– Charles Darwin

I am often asked: “When do you think the economy will return to normal?”

My response: If by “normal” you mean what we had from the 1980s to 2008 — the “if you build it, they will come” economy — the answer is, not anytime in the foreseeable future.

The economic environment has permanently changed, and businesses that don’t adapt to the new environment will become extinct like dinosaurs. Think about Kodak and Polaroid. They were big, strong and probably smart, but they didn’t adapt.

Slower Growth

In the new business environment, economic growth will be much harder to achieve, the income gap will continue to grow and bigger and more intrusive governments at all levels will demand more revenue.

In mid-February, the Congressional Budget Office concluded that potential economic growth for at least the next 10 years will be much lower than what we have experienced for the last few decades. They attribute this to the health system known as Obamacare as well as disincentives to work.

A Growing Income Gap

The growing income gap is well documented. What’s not well documented are the causes.

There are two major ones starting with government policy. Federal Reserve money printing, for example, benefits the most affluent and Wall Street’s financial institutions. Government policy to under-report inflation (which began in earnest in 1994) reduces budget deficits by limiting payouts to Social Security and Medicare recipients and saves interest costs on the debt. But it has kept wage rates from keeping pace with inflation.

If inflation has been understated by just three percentage points per year since 1994, then wage earners, who have only received “cost of living” adjustments, have lost 55% of their purchasing power. No wonder both spouses have to work (some with two jobs) and still have a hard time making ends meet.

But, there is another factor at play here. In the Industrial Revolution, innovation benefited all workers. It wasn’t hard for workers with little formal education to learn how to operate machine tools, and they could master skills needed in the new industrial economy.

But, that is not true today. In fact, the National Federation of Independent Business’s surveys have for some time now shown an increasing trend that businesses cannot find the skills they need. As a result, jobs go unfilled. The jobs that are available require skills only learned through and intensive educational process, such as majoring in engineering or computer science at a university.

These are the folks who are getting the high paying jobs. Those with few or no skills must take much lower-paying service type or minimum wage jobs. In the latest unemployment survey, the unemployment rate among college graduates was 3.3%, for those with high school degrees it was 7.3%, and for those with less than a high school diploma, it was 11.1%. Thus, it appears that the nature of the new technology revolution is also contributing to the income gap.

Other Endemic Factors

For the past five years, multinational corporations have been hoarding cash. Capital expenditures are at their lowest growth levels in six decades. Perhaps these large businesses have recognized that growth will be slow and that revenue growth will be a function of acquisitions.

Finally, new laws, regulation and taxation strangle small businesses — the recognized driver of economic growth for the past 60 years. The stranglehold that regulators have on community banks that restricted lending to small businesses is just one example.

Unfortunately, instead of recognizing that government policies have both slowed the economy and widened the income gap, politicians are likely to use these as wedge issues. So it appears that more regulations and increased taxation on small businesses and higher income earners is certain.

The Survival Mentality

In such a tough, low growth environment, businesses must be more innovative. For instance, 80 million Millennials (those between 15 and 35 years old) will soon have more spending power than any other generation in history. The common characteristic of this generation is they make spending decisions only after consulting social media (friends, Web sites, comments from strangers).

Businesses have to recognize this and play in that space. This generation also has different attitudes toward such things as cars. They are more interested in convenience and access than ownership. In addition, the recognition that the more highly educated are likely to have the disposable income may dictate marketing strategy.

In conclusion, don’t expect a return of the “if you build it, they will come” economy. Without an approach that is fundamentally different from what has been the norm for the past 30 years, many businesses will become extinct.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.
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February 12, 2014

US Economy: Stealth Inflationary Pressures Are Not Yet Priced Into Markets

Posted in Banking, Capital, CBO, Congressional budget office, deflation, Economic Growth, Economy, emerging markets, establishment survey, Europe, Finance, GDP, Inflation, investment advisor, investment banking, investments, job market, labor force, Labor Market, obamacare, payroll tax reductions, Robert Barone, small business, Unemployment at 5:18 PM by Robert Barone

In countries where central banks are printing money, such as the US, UK, eurozone, and Japan, deflation is the fear. On the other hand, inflation is high in countries where central banks have followed more traditional policies, like Brazil (official inflation 5.9%), India (11.5%), Indonesia (8.4%), and Turkey (7.4%). One explanation is the carry trade. Because the central banks of the developed world promised low rates for the long term, the liquidity created by those central banks found its way into the economies of the emerging markets (EM) (read: borrow at low interest rates, invest at high ones). Unfortunately, most of those funds did not find their way into capital investment in those markets, but was instead used for consumption, which has played havoc with EM trade balances. When the demand side (usually measured by GDP) outstrips the supply side (potential GDP), inflation occurs. Now that the bubble in EM countries, caused by excess liquidity in the developed world, is starting to burst — investors no longer believe the carry trade will last much longer — what will become of all of that liquidity?

On February 4, the Congressional Budget Office (CBO), a supposed non-partisan government agency, released a shocking report, “The Budget and Economic Outlook: 2014 to 2024,” projecting that over the next 10 years the Affordable Care Act, commonly referred to as Obamacare, would reduce future employment rolls by more than 2.3 million. Overlooked in that report is the CBO’s projection that “potential” GDP in the US will be much slower over the next 10-year period than it has averaged since 1950; this in an age of innovation where rapid change is considered normal. The CBO says that “changes in people’s economic incentives caused by federal tax and spending policies set in current law are expected to reduce the number of hours worked…” and “that estimate largely reflects changes in labor hours worked owing to the ACA [Affordable Care Act].”

In the US, if the current gap between real GDP and potential GDP closes (and the so-called “slack” in the economy disappears as the CBO projects it will), then, just like in the EMs, any growth on the demand side of GDP above potential GDP, ends up, by definition, as inflation.

There are a many measures that indicate that the economy is much closer to its potential than is generally assumed. One such measure is the fact that, despite record levels of cash flow (used mainly for stock buybacks or dividends), for the past five years, corporations have not reinvested in their plant and equipment. According to David Rosenberg (Gluskin-Sheff), the average age of the capital stock in the US is almost 22 years, an average not seen since 1958. Given the fact that the cost of capital is near an all-time low, there is something holding back such investment. Rosenberg speculates that it is likely found in overregulation and the uncertainty regarding tax policy. An old and aging capital stock implies a much lower growth rate of potential GDP than in the past when the capital stock was younger.

The second issue is the labor force. While the December and January Establishment Survey disappointed the markets (December’s survey reported 75,000 jobs added; January saw a gain of 113,000), nobody is talking about the Household Survey. This is the survey from which the “official” unemployment rate is calculated. While more volatile that the Establishment Survey, the Household Survey showed gains of 143,000 jobs in December and a whopping 638,000 in January. When combined with other surveys (NFIB) which show that 23% of small businesses have at least one open position that they cannot fill (a six-year high according to Rosenberg), and that there is a sustained uptrend in voluntary quits, it would appear that the Establishment Survey is the outlier and that the labor market is quite tight.

If, indeed, the CBO is correct and potential GDP growth will slow over the next 10 years due to Obamacare, a tight labor market in conjunction with old capital stock will only exacerbate that situation. Since the financial crisis, the unemployment rate has fallen from 10.0% in October ’09 to 6.6% in January ’14, a 3.4 percentage point decline. During that period of time, the annual GDP growth rate has been about 2.4%. After the recession of the ’90s, to get the unemployment rate to fall 3.4 percentage points (from 7.8% to 4.4%), it took an annualized GDP growth rate of 3.7%. The lower GDP growth required to reduce the unemployment rate implies that the gap between actual and potential GDP is either small or nonexistent.

The aging of the capital stock, lack of new investment, and the tightening labor market indicate that resources are in short supply, which means that there is a strong probability that any semblance of robust economic growth will be accompanied by inflation. Adding to such pressure is the liquidity sloshing around the EM world. If it finds its way home, as appears to be happening, unless much of it goes into new capital formation (which is unlikely given the current regulatory and tax regimes), we are likely to see growing inflationary pressures much sooner than is currently priced into the financial markets.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

February 4, 2014

Existing Public Policy Fosters a Growing Income Gap

Posted in business, Business Friendly, Dodd Frank, Economic Growth, Economy, Federal Reserve, Finance, income gap, Inflation, lending, Public Policy, Quantitative Easing, small business at 9:12 PM by Robert Barone

There is no doubt that the gap between the rich and the middle class and poor has widened in recent years. And the most recent studies confirm a continuation of that trend with capital gains playing a major role.

What is ironic is that public policies — some long practiced, some new, — contribute significantly to the problem. Recognizing and fixing such policy issues, however, is easier said than done.

In this post, I will discuss three such policies: 1) The asset inflation policies of the Fed; 2) The policy that significantly understates inflation; and 3) The policies that strangle lending to small business. There are many other public policies, such as work disincentives, that also have an impact, but I’ll discuss them another time

Fed Policy

Since the financial crisis, the Fed, through its “quantitative-easing” policies, has relied upon the “wealth effect” via equity asset price inflation to combat the so-called deflationary forces that had built up in the economy.

Each time a QE policy ended, there was a big decline in equity prices. Those declines prompted another round of QE.

As indicated above, capital gains have played a major role in the recent growth of the income gap. Those gains also played a major role in the dot.com and subprime bubbles of the recent past.

Inflation

In his Jan. 29 missive to clients, David Rosenberg of Gluskin Sheff, a wealth-management firm, said that “if we were to replace the imputed rent measure of CPI (consumer price index) with the actual transaction price measure of the CS-20 [Case Shiller home price index], core inflation would be 5.3% today, not 1.7% as per the ‘official’ government number…”

John Williams (www.shadowstats.com) indicates that, using the 1990 CPI computation, inflation in the U.S. was 4.9% in 2013; using the 1980 computation method, it was 9.1%.

Those of you old enough may remember that in 1980 the then new Fed Chairman, Paul Volker, began to raise interest rates to double-digit levels to combat an inflation that was not much higher than the 9.1% of today (if the 1980 methodology is used).

Over the years the Bureau of Labor Statistics has changed the computation method for CPI, in effect, significantly biasing it to produce a much lower inflation rate.

In a post I wrote last September (“Hidden Inflation Slows Growth, Holds Down Wages,” TheStreet.com, 9/13/13), I showed how the growth of wages earned by middle-class employees has hugged the “official” inflation trend.

If that “official” inflation trend understates real inflation by 3% per year (the difference between Williams’ computation using the 1990 methodology and 2013’s “official” rate is 3.1%), over a 20-year period, the real purchasing power of that wage would fall by more than 80%.

That helps to explain why both husbands and wives must work today, why the birth rate is falling and why the income gap is widening.
Once again, changing the inflation measurement problem is easier said than done. In the U.S., Japan, the U.K and the eurozone, debt levels are a huge issue. Lower inflation rates keep interest rates low, allow new borrowing (budget deficits) at low rates and keep the interest cost of the debt manageable (at least temporarily).

Also, a low official rate keeps the cost-of-living adjustments for social programs — Social Security, Medicare and government pensions — low. As a result, Social Security, Medicare and pension payments are significantly lower than they otherwise would be. Returning to the older, more accurate inflation measures would truly be budget busting.

Constraints on Small Business Lending

One of the reasons that the economic recovery has been so sluggish is the inability for small business to expand. Since the financial crisis, much of the money creation by the Fed has ended up as excess reserves in the banking system (now more than $2.3 trillion).

Small businesses employ more than 75% of the workforce. So, why aren’t banks lending to small businesses?

In prior periods of economic growth, especially in the 1990s and the first few years of the current century, it was the small and intermediate-sized banks that made loans to small businesses in their communities.

Today, for many of the banks that survived the last five years, there are so many newly imposed reporting and lending constraints (Dodd-Frank) and such a fear of regulatory criticism, fines or other disciplinary action that these institutions won’t take any risk at all. In earlier times, the annual number of new community bank charters was always in the high double digits.

But, since 2011, the FDIC has approved only one new bank charter that wasn’t for the purpose of saving an existing troubled bank. Only one!

In effect, the federal regulators now run the community banking system from seats of power in their far away offices.

Small businesses cannot grow due to the unavailability of funding caused by overregulation and government imposed constraints. This holds down the income growth of much of the entrepreneurial class and is a significant contributor to income inequality. Of the policies discussed in this post, this would be the easiest to change.

Conclusion

There is definitely a growing income gap, but, much of it is the result of public policy. New elections or new legislation won’t fix these policies. The first step is recognition. But, as I’ve pointed out, many of these policies are rooted in the fabric of government.

There is little desire on the part of those comfortably in power to recognize them, much less to initiate any changes.

 

 

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp)
are available to discuss client investment needs.
Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

 

January 14, 2014

Why Gold Prices Dropped in 2013

Posted in Banking, Big Banks, Economic Growth, Economy, Europe, Federal Reserve, Finance, Foreign, gold, Inflation, interest rates, investment advisor, investments, Robert Barone at 6:39 PM by Robert Barone

Most seasoned investors have some allocation to precious metals in their portfolios, most often gold. They believe that such an allocation protects them, as it is a hedge, or an insurance policy, against the proliferation of paper (fiat) money by the world’s largest central banks. Fiat money is not backed by real physical assets. In concept, I agree with this sentiment. Most investors who invest in precious metals ETFs, such as the SPDR Gold Trust ETF (NYSEARCA:GLD), through the supposedly regulated stock exchanges (“paper gold”) believe that they actually have a hedge against future inflation. In what follows, I will try to explain why they may not, and why their investments in paper gold may just be speculation.

On February 5, 1981, then Fed Chairman Paul Volcker said that the Fed had made a “commitment to a monetary policy consistent with reducing inflation…” Contrast that with the statement of outgoing Fed Chairman Bernanke on December 18, 2013: “We are very committed to making sure that inflation does not stay too low…”

During 2013, the price of gold fell more than 28% (from $165.17/oz. to $118.36/oz.) despite the fact that other assets like real estate and equities each rose at double-digit rates. It is perplexing that the price of the hedge against inflation is falling in the face of a money-printing orgy at all of the world’s major central banks. Despite the fact that these central banks have fought the inflation scourge for half of a century, suddenly they have all adopted policies that espouse inflation as something desirable. The fall in the price of gold is even more perplexing because there are reports of record demand for physical gold, especially in Asia, and that some of the mints can’t keep up with the demand for standardized product. In his year-end missive, John Hathaway of Tocqueville.com says that “the manager of one of the largest Swiss refiners stated that after almost doubling capacity this year, ‘they put on three shifts, they’re working 24 hours a day…and every time [we] think it’s going to slow down, [we] get more orders…70% of the kilo bar fabrication is going to China.'”

One would also think that the price of gold should be rising because of a growing loss of confidence in fiat currencies. Here are some indicators:

The growing interest in Bitcoin as an alternative to government-issued currencies. One should ask, why did the price of Bitcoin rise from $13.51 on December 31, 2012 to $754.76 on December 30, 2013 while the price of gold fell? As you will see later in this essay, the answer lies in leverage. The gold market is leveraged; Bitcoin is not (at least, not yet).

The volatility that the Fed has caused in emerging market economies by flooding the world with dollars at zero interest is another reason the price of gold should be rising. The Fed’s announced zero-rate policy with a time horizon caused huge capital flows into emerging market economies by hedge funds looking for yield. The inflows caused disruption to the immature financial systems in those emerging markets. And then, with the utterance of a single word, “tapering,” all of the hedge funds headed for the exits at once. The Indian rupee, for example, which was trading around 53 rupees/dollar in May 2013, fell to 69 near the end of August, a 30% loss of value. Such behavior has stirred up new interest on the part of major international players (China, Russia) to have an alternative to the dollar as the world’s reserve currency. Don’t dismiss this as political posturing. It is based on irresponsible Fed policy in its role as the caretaker of the world’s reserve currency. As the world moves toward an alternative reserve currency, the dollar will weaken significantly relative to other currencies, and, theoretically, to gold (and even Bitcoin).

The loss of confidence on the part of some sovereign nations that the gold they have stored in foreign bank vaults is safe. Two examples immediately come to mind: Venezuela and Germany. In August of 2011, the President of Venezuela, Hugo Chavez, demanded that the London bullion banks that were holding Venezuela’s gold ship it to Caracas. (Again, don’t dismiss this as political posturing.) Despite the fact that the shipment could have been carried on a single cargo plane, it took until late January 2012 (17 months), for the London banks to completely comply. One should wonder why. Then, the German Bundesbank asked for an audit of its gold holdings at the Fed. One knows how the Fed has resisted audits from Congress, so why should a request from a German bank meet with any different result? After political escalation, a German minister was permitted to see a room full of gold at the New York Fed. In early 2013, the Bundesbank publicly announced that its intent was to repatriate its gold from the vaults in Paris, London, and New York. We have now learned that it will take seven years for the New York Fed to ship the gold earmarked as belonging to Germany in the Fed’s vaults. One should wonder why such a long delay.

In the face of all of this — unparalleled money printing, the rise in the prices of real estate and equities in 2013, and the creeping suspicions regarding the real value of fiat currencies — how is it that the price of gold fell 28% in 2013? The answer lies in leverage and hypothecation, the modus operandi of Wall Street, London, and financiers worldwide. The paper gold market, the one that trades the ETFs such as the SPDR Gold Trust, is 92 times bigger than the physical supply of gold according to Tocqueville’s John Hathaway. Think about that. It means that each physical ounce of gold that actually exists has been loaned, pledged, and re-loaned 92 times on average. Each holder in the paper gold market thinks that the ounce of paper gold held in the brokerage account is backed by an ounce of real gold. But there are, on average, 92 others who apparently have a claim on the same real, physical ounce.

The answer to the question, why did gold fall 28% in 2013 when, theoretically, it should have risen, is that Wall Street, London, and hedge funds have turned the paper gold market into a market of speculation, where the price rises or falls, not based on the purchasing power of currencies (the hedging characteristic of gold), but on such things as whether or not the Fed will taper, what impact Iranian nuclear talks will have on oil flows, if the interest rates in the eurozone periphery are likely to rise or fall, etc.

In my next article, I will explain how all of this occurred, and what investors who want to hedge and not speculate should do.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 30, 2013

8 U.S. business predictions for 2014

Posted in Auto Industry, business, Economic Growth, Economy, Finance, GDP, gold, government, Housing Market, Inflation, interest rates, investment advisor, investment banking, Labor Market, Manufacturing, Robert Barone, Unemployment, Wall Street at 8:45 PM by Robert Barone

The holiday season is the traditional time of year to prognosticate about the upcoming year. But, before I start, I want to make a distinction between short-term and long-term forecasts.

Long-term trends are just that, and they unfold slowly. And, while I have great concerns about the long-term consequences of inflation, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and resulting excess bank reserves, and the freight train of unfunded liabilities which will impact the debt and deficit, because these are long-term issues and simply don’t appear overnight, I do not believe there is anything contradictory about being optimistic about the short-term.

With that caveat, here are my predictions for 2014:

1. Real GDP will grow faster in 2014 (3.5%): The “fiscal drag” that caused headwinds for the economy has now passed with the signing of the first budget in four years in mid-December. Since 2009, governments at all levels have been shedding jobs. But, that has now all changed. The November jobs reports show that employment at all levels of government has turned positive.

No matter your view of the desirability of this for the long-term, in the short-term, those employees receive paychecks and consume goods and services. I predict the real gross domestic product growth rate will be more than 3.5 percent in 2014.

2. Manufacturing and trade are healthy and will get better in 2014: The Institute for Supply Management’s indexes, both manufacturing and non-manufacturing, are as high or higher than they were in the ’05-’06 boom. In November, industrial production finally exceeded its ’07 prior peak level.

Auto sales today are as frothy as they were in the pre-recession boom, and auto sales in the holiday buying period are destined to surprise to the upside. Online sales in the weekend before Christmas overwhelmed both UPS and FedEx, causing many gifts to be delivered on the 26th.

3. Housing, while not near its old bubble peak, has turned the corner: Part of the reason the economy is not overheating is housing. While November’s housing starts surprised to the upside, they still only represent 53 percent of their bubble peak. Nevertheless, because new home construction has been in the doldrums for the past six years, the resurgence evident in the economy has pushed the median price of homes to the point where many homeowners, who were underwater just a couple of years ago, can now show positive home equity on their balance sheets

While interest rates have risen and may be a cause for concern for housing, they are still very low by historic standards, and we have a Fed that, on Dec. 18, recommitted to keeping them down for a period much longer than the market ever anticipated.

4. The unemployment rate will end 2014 somewhere near 6%: Because the popular unemployment index is a lot higher today than it was in the ’05-’06 boom (7 percent vs. 5 percent), the popular media assumes that the labor markets are still loose. But, demographics and incentives to work have changed over the past seven years.

The labor sub-indicators imply much tighter labor conditions than the traditional unemployment index would lead one to believe. Recent data for nonfarm payrolls are equivalent to their monthly numbers in ’05-’06. Weekly new jobless claims are in a steep downtrend. The sub-indexes for layoffs and discharges are lower than they were in ’05-’06. And hard-to-fill-position and job-opening subindexes are in definite uptrends and are approaching ’05-’06 levels. As a result, expect a steady decline in the unemployment rate in 2014.

5. Investment in new plant & equipment will rise in 2014: For the past 5 years, large-cap corporations have hoarded cash and have not reinvested in their businesses. As a result, because equipment and technology is older, labor productivity has stagnated. This is one reason for the strong labor market. In 2014, I predict there will be an upturn in the reinvestment cycle. Beneficiaries will be technology companies and banks.

6. Inflation will be higher in 2014, both “officially” and in reality: While every individual player in the financial markets knows that everyday prices are rising, each espouses the Fed’s deflation theme, perhaps only to play along hoping the Fed will continue printing money.

Are we to believe that the jump of retail sales in October of 0.6 percent followed by 0.7 percent in November were all without price increases as the Bureau of Labor Statistics says? The “official” consumer price index says that airline fares have not increased despite the 18 percent growth of airline revenues in 2013 (bag check fees, etc.)? Should we believe that double-digit revenue growth rates at restaurants are volume-only and we are just eating more? I don’t know what the actual rate of inflation is, but it sure feels like it is higher than 5 percent. In 2014, it will be even higher than that.

7. Equity markets will rise in 2014: The fiscal headwinds are behind us; industrial production and sales are strong; housing is healing, the rise in home prices have generally raised consumer confidence; there appears to be the beginning of an upturn in the capital investment cycle; and, most important, the labor markets are strong. Any equity market corrections should be bought. Meanwhile, longer-duration bonds should be avoided unless there is an accompanying hedge instrument.

8. Gold — it should rise in 2014, but this is a tricky market: Every indicator points to a rise in the price of gold, especially since all of the world’s major central banks are printing money at record rates. But, contrary to logic, the price of gold has fallen in 2013 by nearly 30 percent.

The reason behind this lies with leverage and hypothecation — getting a loan using collateral — in the gold market. Once again, Wall Street has discovered that money could be made by leveraging; and the paper gold market is about 100 times larger than the physical market. When you have that kind of leverage, collusion, price fixing, or just plain panic can quickly move markets.

As inflation is recognized, the price of gold (both physical and paper) should rise. In a healthy economic year, as I predict for 2014, a collapse in the paper gold market is unlikely, and perhaps the price of gold will rise in response to rapidly expanding fiat money. But beware. The only safe gold is what you can hold in your hand.

December 27, 2013

Part II: The Long-Term Outlook – Even a Strong Economy Doesn’t Change the Ultimate Outcome

Posted in business, debt, Economic Growth, Economy, Europe, Finance, Foreign, Inflation, investment advisor, investment banking, investments, Markets, National Deblt, Robert Barone at 4:46 PM by Robert Barone

If you’ve read Part I of this year end outlook, you know that it is our view that the underlying private sector is healthy and, except for the fact that the real rate of inflation is much faster than the ‘official’ rate, we could well have a short period of prosperity.

Unfortunately, our long-term outlook is not as sanguine as our short-term view.  The eventual recognition of the inflation issue, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and the resulting excess bank reserves, and the freight train of unfunded liabilities and its impact on the debt and deficit are issues that have large negative long-term consequences.  Remember, the long-term unfolds slowly, and we don’t expect that we will wake up one day to find that all has changed.  Still, the changes discussed below could very well take place over the next decade, and investors need to be prepared.

The Dollar as the Reserve Currency

The dollar is currently the world’s reserve currency.  Most world trade takes place in dollars, even if no American entity is involved.  Because world trade has rapidly expanded over the past 20 years, more dollars have been needed than those required for the U.S. economy alone.  As a result, the U.S. has been able to run large deficits without any apparent significant impact on the dollar’s value relative to other major currencies.  Any other country that runs a large deficit relative to their GDP suffers significant currency devaluation.  Current policy in Japan is a prime example.  A weakening dollar has implications for the prices of hard assets.

In addition, the Fed’s policy of Quantitative Easing (essentially money printing) has disrupted emerging market economies.  Zero rates and money creation caused hedge fund managers to leverage at low rates and move large volumes of money offshore to emerging nations where interest rates were higher.  The initial fear of “taper” in May and June caused huge and sudden capital outflows from those countries resulting in massive economic dislocation in those markets.  In India, for example, the Rupee was pummeled as the hedge fund investors, fearing that interest rates were about to suddenly rise, all tried to unwind their Rupee investments at the same time.  And now that ‘taper’ has officially started and longer-term rates are expected to rise, these issues will continue.  Those countries have all taken defensive measures.  India, for example, imposed taxes on gold imports, which has impacted the gold markets but has reduced India’s balance of payments deficit.

As a result of such tone deafness on the part of the Fed, and because there now appears to be enough dollars in the world for the current level of trade, the international appetite for U.S. dollars is clearly on the wane.  Japan and China, the two largest holders of Treasury debt, have recently reduced purchases.  Most emerging market nations and large players like Russia and China have vocally called for an alternative to the dollar as the world’s reserve currency.  This movement is alive and well.

The Fed’s Balance Sheet

As the economy expands, the size of the Fed’s balance sheet and the level of excess bank reserves will become a problem.  There are $2.3 trillion of bank reserves in excess of what are ‘required’  under the law and regulations.  (Required reserves for the U.S. banking system are $.067 trillion; so, the system has 34x more reserves than it needs.)  Under ‘normal’ conditions, and the way the system was designed to work, if the economy got too hot, the Fed could sell a small amount of securities out of its portfolio which would reduce bank reserves to the point where banks would have to ‘borrow’ from the Fed.  Because bankers are hesitant to do that, and because the Fed could raise the ‘discount’ rate, the rate charged for the borrowings, the Fed could control new lending and thus the economic expansion.  This isn’t possible today as the Fed would have to sell $2.2 trillion to cause banks to have to borrow.  Such a volume of sales would likely cause a crisis in the financial system, or even collapse.  Today, the only way the Fed has to stop the banks from lending is to pay them not to lend – this is exactly the opposite of the intent of the original legislation and the opposite of how the Fed has worked for most of its 100 year history.

Furthermore, given the growing lack of confidence in the dollar as the world’s reserve currency, if fiscal budget deficits grow in the future, the Fed may end up as the major lender (i.e., lender of last resort) for the U.S. Treasury.  That simply means more money creation.

Unfunded Liabilities-

The U.S. Treasury officially recognizes $85 trillion as the amount of unfunded liabilities of the Federal Government.  Other professionals set this number near $120 trillion.  For comparison, the annual U.S. GDP is about $16 trillion.  The budget deficit reported in the media is a cash flow deficit (tax collections minus expenditures).  The budget deficit doesn’t include promises made for future payments (Medicare, Medicaid, Social Security, government pensions) which have been running between $4 and $5 trillion annually for the past few years.  These amounts simply get added to the ‘unfunded’ liability number.

As the population ages, these payments will have to be made, and the budget may become overwhelmed. (You see the relevance of the remark made above about the Fed being the lender of last resort for the Treasury.)   This is the heart of the debate about ‘entitlements’ that has been front and center for the past decade.

 Solutions (none of which you will like)

 Philipp Bagus is a fellow at the Ludwig von Mises Institute in Europe.  He is well known in Europe for his work on financial issues there.  In a recent paper, Bagus says that there are several possible ways out of the current money printing predicament.  Any one or a combination is possible.  We have put them in an order of most likely to least likely to be used:

  •  Inflation – this is the natural outcome of printing money;
  • Financial Repression – this is current Fed policy; savers and retirees bear a disproportionately large burden as inflation eats at their principle but there is no safe way to earn a positive real rate of return;
  • Pay Off Debt – this means much higher levels of taxation, and is definitely a real possibility.  In Europe, the International Monetary Fund (IMF) has proposed a one-time 10% wealth tax.  As the unfunded liabilities push up the federal deficit, expect such proposals in the U.S.;
  • Bail-In – In ’08-’09 we saw ‘bail-outs’ where the government saved GM, Chrysler, AIG and the Too Big to Fail banks by buying stock or otherwise recapitalizing them.  A ‘bail-in’ refers to the financial system.  Banks and other depositories have liabilities called deposits.  The depositors do not consider themselves ‘lenders.’  But, in a ‘bail-in,’ it is the depositors who lose.  Their deposits are ‘converted’ to equity in the bank.  When they try to sell their bank shares, they find that it will fetch only a fraction of the value of their deposits.  A variant of this is what happened in Cyprus in the spring of 2013.  Because of the distaste the public now has for ‘bail-outs,’ if there is another financial crisis, this is likely to be the method used;
  • Default on Entitlements – when we talk about ‘entitlement reform’ in the U.S., we really mean at least a partial default.  It is likely that some people simply won’t get what they were promised.  We put this low on the list because we have witnessed a political process that won’t deal with the issue;
  • Repudiate Debt – Because the government can simply print money to pay it debts, this is the least likely of all of the possibilities in the U.S.

The long-term issues are serious.  And not addressing them simply means a higher level of pain when addressing them is required.   Remember, these are long-term issues.  They are all not likely to occur at the same time, nor will they simply appear overnight.  The first signs of trouble will occur when markets begin to recognize that the ‘official’ inflation rate significantly understates reality, or that the inflation data become so overwhelming that they can no longer be masked.  Even then, markets may come to tolerate higher inflation, as after 100 years of fighting inflation, the Fed and the world’s major central banks have embraced it as a good thing.

Meanwhile, as set forth in Part I of this paper, the immediate outlook for the economy is upbeat.  Enjoy it while it lasts.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp  and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Part I: The Short-Term Outlook – A Strong and Accelerating Economy

Posted in Banking, business, Economic Growth, Economy, Federal Reserve, Finance, Housing Market, investment advisor, investment banking, investments, Markets, mortgage rates, Robert Barone at 4:41 PM by Robert Barone

Those who read our blogs know that over the past 6 months or so, we have turned positive on the underlying private sector of the U.S. economy.  We have had comments from several readers about this apparent change of heart, some of them almost in disbelief.  So, let us dispel any doubts.  There is a huge difference between the short-term and the long-term outlooks.  Let’s realize that long-term trends are just that, long-term, and that they take a long time to play out.  As you will see if you read through both parts of this year end outlook, our long-term views haven’t changed.  But, since the long-term doesn’t just suddenly appear, there really isn’t anything contradictory in being optimistic about the short-term.  As a result, we have divided this outlook up into its two logical parts, the short-term and the long-term.

Let’s start with the short-term.  First, at least through 2014 and probably 2015, the ‘fiscal drag’ that caused headwinds for the economy has now passed with the signing of the budget deal in mid-December.  In his December 18th press conference, Fed Chairman Bernanke indicated that four years after the trough of the ’01 recession, employees at all levels of government had grown by 400,000; but at the same point today, that number is -600,000, i.e., a difference of a million jobs.  Think of that when you think about ‘fiscal drag.’  The November jobs data shows that jobs at all levels of government have now turned positive.  No matter your view of the desirability of this, those employees receive paychecks and can consume goods and services.  So, from a short-term point of view, the ‘fiscal drag’ has ended, and, all other things being equal, this will actually spur the growth rate of real GDP.

Manufacturing and Trade

The institute for Supply Management’s (ISM) indexes, both manufacturing and non-manufacturing, are as high or higher than they were in the ’05-’06 boom period.  This is shown in the chart immediately below.

pic 1

Shown in the next chart is industrial production, which in November, finally exceeded its ’07 peak.

Pic 2

Now look below at the auto chart.  Sales are as frothy today as they were in the pre-recession boom.  Sales for the holiday buying period are destined to surprise to the upside.

Pic 3 

Housing

Part of the reason that the economy is not overheating is housing.  The chart clearly shows that housing starts are significantly lagging their ’05-’06 levels.  But, recognize that ’05-’06 was the height of the housing bubble.

Pic 4

November’s housing starts surprised to the upside.  But, they are still only 53% of their bubble peak.  Nevertheless, because new home construction has been in the doldrums for the past six years, the resurgence evident in the economy has pushed the median price of a new home north of what it was then.  In addition, the lack of construction has put the months’ supply of new homes at less than 3.  In the housing bubble, when everyone was in the market, the average level of supply was 4 months.  So, in some respects, the current housing market is hotter than it was at the height of the bubble.  And, while interest rates have risen and are a cause for concern, they are still very low by historic standards, and we have a Fed that on December 18th recommitted to keeping them down for a period much longer than the market had anticipated.

 Labor Markets

Because the popular unemployment index is a lot higher today than it was in the ’05-’06 boom (7% vs. 5%), the popular media assumes that the labor markets are still loose.  But, demographics and incentives to work have changed over the past seven years.  The labor sub-indicators imply a much tighter labor market than the traditional unemployment index would lead one to believe.  Recent new nonfarm payrolls are equivalent to their monthly gains of ’05-’06.  The weekly Initial Jobless Claims number for the week ending 11/30 was 298,000.  Except for one week this past September, you have to go all the way back to May ’07 to find a number that low.  The first chart below shows the definite downtrend in new and continuing jobless claims.

Pic 5

The next chart shows that layoffs and discharges are lower than they were in ’05-’06 and that both the “Job Openings” and “Jobs Hard to Fill” sub-indexes are in up trends and are approaching ’05-’06 levels.

Pic 6 

The Aggregates

So, while auto sales are booming, the labor markets are tight, and manufacturing and services are expanding at or near boom levels, why do the aggregates (Real GDP, for example) appear so depressed?  One explanation that we think has some credibility, is that there has been an expansion in the underground economy (barter; working for cash, etc.).  The ‘fiscal drag’ headwinds discussed earlier, have, no doubt, had a large impact on the sluggish growth in the aggregates.  On a positive note, the latest revisions to Q3 ’13 Real GDP show a growth rate of 4.1%, which, on its face, supports our short-term optimism.  And until mid-December, the markets had discounted this as resulting mainly from growth in unwanted inventories.  But Black Friday and Cyber Monday sales along with upbeat ongoing retail reports tell us something different, i.e., the inventory growth was not unwanted at all.  While the markets expect a 2% Real GDP growth for Q4 ’13, don’t be surprised if it is much higher.

Short-term Implications

The underlying data, at least for the next 6 to 12 months, point to a strengthening economy.  Certainly, a stock market correction is possible.  We haven’t had one for more than 2 years.  But, while possible, a significant downdraft like those of ’01 or ’09, don’t typically occur when the economy is accelerating (1987 is an exception) without an extraneous and unanticipated shock.  With the signing of the first budget deal in four years, and with the Fed clearing the air about tapering and actually extending its announced period of zero interest rates, almost all of the short-term worries appear to be behind us, except one.

 Inflation – The Potential Fly in the Ointment

The ‘official’ Consumer Price index (CPI) was flat in November, dominated, as it has been all autumn, by the fall back in gasoline prices.  Somehow, while we all know that everyday prices are rising at a significant pace, the markets have bought into the deflation theme.  Perhaps the belief is that if the markets play along with the Fed’s low inflation theme, the Fed will remain easier for longer.

In his December 16th blog, David Rosenberg (Gluskin-Sheff) has the following to say about inflation:

I have a tough time reconciling the ‘official’ inflation data with what’s happening in the real world… the .7% jump in retail sales in November on top of +.6% in October – these gains were all in volume terms?  No price increases at all?  Restaurants are now registering sales at a double-digit annual rate… No price increases here?  The BLS tells us in the CPI data that there is no pricing power in the airline industry and yet the sector is the best performing YTD within the equity markets…  global airline service fees have soared 18% in 2013… these [fees] are becoming an ever-greater share of the revenue pie and one must wonder if they are getting adequately captured in the CPI data.

Inflation could be the fly in the ointment for 2014.  As long as the markets play along with the Fed’s deflation theme, as we expect they will as long as they can, the economy and markets will do just fine (this doesn’t mean there won’t be a correction in the equity markets, as we haven’t had a meaningful one for two years).  But sooner, or later, something will have to be done about inflation.  We will close this Part I with a quote from Jim Rogers, the commodity guru (Barron’s, October 12, 2013):

The price of nearly everything is going up.  We have inflation in India, China, Norway, Australia – everywhere but the U.S. Bureau of Labor Statistics.  I’m telling you, they’re lying.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

 

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

 

 

November 5, 2012

Nation has impediments to economic growth

Posted in Economic Growth, recession, Uncategorized tagged , at 8:30 PM by Robert Barone

In my last column, I analyzed why headline data showing significant job growth might be misleading without a deep analysis of the underlying data. The fact is, the economy cannot grow without a healthy consumer, and the consumer cannot become healthy without a robust job market. This is common sense. The accompanying table sheds a lot of light on the health of those labor markets.

From July 2009 to September 2012, 3 million jobs have reappeared in America. From December 2009 to September 2012, that number is 5 million; 2 million jobs were lost between July and December 2009. But, if you stopped with that data, you would not have the real story.

• Over the period measured, jobs held by seniors, age 55 and older, grew by 3.5 million. That means that, on net, all jobs in other age brackets fell by 500,000.

• Those in the 20-24 age group (college graduates) grew by 730,000.

• Jobs for 16- to 19-year-olds fell by about 500,000.

• But the real issue here is that those in their prime earning years (ages 25-54) have lost 730,000 jobs. It is clear that, for the middle class, the recession has continued. And, it appears that Vice President Joe Biden hit the nail on the head when, in the vice presidential debate, he said that during the past four years, the middle class has been “crushed.”

Why has this occurred?

• After two devastating drops in the equity markets since 2001, and with a Federal Reserve policy of 0 percent interest rates, which dramatically reduces returns from now depleted retirement assets, seniors either are not retiring or are taking part-time employment just to survive.

• As you can see from the table, the number of part-time jobs has risen by 4 million since July 2009. These are folks who want full-time jobs but can’t find them. Remember, as I indicated in my last column, the headline measure of unemployment (7.8 percent in September) counts part-timers as fully employed.

• With increased levels of taxation (new upcoming Obamacare taxes plus promised new taxes on small businesses, which are those that earn more than $250,000 per year) and more regulations, employers are more than happy to use part-time workers where possible. By doing so, they have lower health care costs, lower hourly wage costs (the employee has a take-it-or-leave-it choice) and much lower long-term employment benefit and retirement costs.

Is it any wonder that household median income has fallen from $54,489 to $50,054 since the recession began? So, while the actual count of full- and part-time jobs has risen by 3 or 5 million depending on your starting date (July or December 2009), the vast majority of these have been part-time, low-wage jobs, and have been taken by seniors who simply cannot afford to retire. Meanwhile, full-time higher wage work for middle-class families in their prime earning years (25-54) has continued to contract after the recession supposedly ended.

Clearly, the economy won’t heal until these trends reverse. All of the rest of the supposed economic indicators (housing, GDP, stock prices, etc.) are irrelevant. Seniors need to be able to retire and have their full-time jobs taken by younger workers. Regulatory and government-imposed costs to business of hiring full-time employees need to be addressed. These are long-term issues. Recognition of these issues is a necessary first step — one we haven’t yet taken.

I suspect that the markets will pay more attention to these issues after the election, no matter who the winner is.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.

Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

August 2, 2012

Equities: Is a bear market inevitable in this economy?

Posted in debt, Economic Growth, Economy, Europe, Finance, government, investment banking, investments, payroll tax reductions, recession, Stocks, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , , , , at 7:40 PM by Robert Barone

All of the data and the trends in the data indicate that it is possible that a recession might already have begun.

• Job creation has been dismal in the second quarter, with little hope for improvement soon; jobless claims are, once again, on the rise.

• Retail sales have fallen three months in a row; this has never occurred without an ensuing recession. What is of greater concern is that this has occurred while gasoline prices have been falling.

• While market pundits have cheered small gains in housing data, it is clear that housing is still bottom bouncing. Changes in foreclosure laws have caused supply constraints that have made it appear that home prices are rising again.

• Industrial production, the one bright spot in the economy, showed a decline in May before recovering somewhat in June.

• The drought has caused raw food and commodity prices to spike. These will soon translate into higher food and raw input costs. (Is anyone now questioning the wisdom of the congressional mandate to produce increasing quantities of ethanol from corn instead of sugar?)

 • Consumer confidence continues at levels below those seen in past recessions . Much of this is due to uncertainty surrounding fiscal policy and taxes.

• In the June Philadelphia Fed Survey, manufacturers were asked to list reasons for slowing production; 52 percent cited uncertain tax policy and government regulations.

• Real incomes are falling. The downward bias in the inflation numbers produced by the government inflates the reported GDP numbers. It has been my view that, as a result of the biased reporting, the recession never really ended, and real GDP is much lower than reported.

 Equity market up for year

 Nevertheless, despite all of the poor data, the equity markets have held up. At 1,338 (the closing level on July 25), the S&P 500 is still 6.4 percent higher than it was at the beginning of the year. This is strange, given that every other major market in the world is down 20 percent and in bear market territory. Here are a couple of possible explanations:

• The equity markets used to be a leading indicator of the economy. Severe market corrections (20 percent or more) usually meant recession was either imminent or already here. But, with the advent of computerized trading, the market now appears to be more of a coincident indicator. In late 2007, when the last recession began, the market was only off 5 percent from its October peak.

• Europe: There is such financial chaos in Europe that a flight to the dollar is continuing. Because higher quality bond yields are so low, some of the funds have found their way into the U.S. equity markets, thus keeping them buoyed.

Neither of these two reasons should give investors any confidence that U.S. markets can hold up. Besides the poor internal economic data within the U.S., worldwide data have been weak. In addition to the obvious problems in Europe, China is in a much slower growth mode, as is Japan, the rest of Asia, and even the commodity producers like Australia and Canada.

European soap opera
 
Europe is a whole other issue. American markets have benefited from their financial issues, but when panic and contagion show up over there, markets behave poorly over here. We have seen this time and again as the European drama (really a soap opera) has unfolded. It would be far better for the European politicians to come up with an
orderly plan for countries to exit the monetary union than to deny that the union isn’t in any danger of falling apart.

 

Solvable “fiscal cliff”

Finally, the approaching “fiscal cliff” in the U.S. is another wild card that could have a significant impact on capital markets. The good thing about the “fiscal cliff” is that it isn’t an outside force being imposed. The cliff is avoidable and completely under the control of Congress and the president.

With all of this going on, is a bear market inevitable? While I think that the confluence of events (worldwide economic slowdown, slowdown in the U.S., European financial chaos, “fiscal cliff”) make it likely, as I indicated in my last column, the application of “business friendly” policies could prevent it.

Until visibility into policy becomes clearer, investors should continue to be extremely cautious. They should remain liquid.

 Finally, the U.S. economy is so fragile that any external shock, like a financial implosion in Europe, is certain to have negative impacts on U.S. markets. Policy responses to economic slowdown or financial chaos (e.g., printing of money by the European Central Bank or QE3 by the Fed) are likely to have a positive impact on the value of precious metals and commodities. And the ongoing drought will definitely move food and commodity prices upward.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

July 23, 2012

Time for us to make enlightened policies

Posted in Armageddon, Bankruptcy, debt, Economic Growth, Economy, Europe, Finance, Foreign, recession, Spain, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , at 8:10 PM by Robert Barone

On July 6, the country received another disappointing jobs report. For the month, the establishment survey indicated jobs grew by 80,000; for the quarter, such growth averaged 75,000, about one-third of the 26,000 monthly average for the first quarter. Clearly, the worldwide slowdown in Europe, China, India, Brazil, etc. is having an impact here.
 
Deleveraging and slow growth
 
Let’s be clear. We are in the midst of a worldwide debt deleveraging (i.e., consumers are paying down debt instead of consuming). So, absent another round of sweeping innovation anytime soon (e.g. the Internet), in the natural course of things, economic growth is going to be painfully hard to come by. As a result, it is doubly important that economic policies promote the growth that is available.
 
Policies are key
 
Clearly, monetary policy has led with pedal-to-the-metal and unconventional therapies. On the fiscal side, the Keynesian remedies (huge deficits) have been applied. Together, however, such policies haven’t worked well enough to establish a solid economic foundation, as the recent data prove. For those who study economic history, it is clear that deficit spending alone doesn’t work if government is simply stepping into the role of debtor in place of households, as total debt owed has continued to rise.The scary part is the interest cost of the rapidly accumulating debt when interest rates rise. For those who don’t believe me, just look at Greece, Portugal, Ireland, Spain, Cyprus and Italy in today’s world. Rising interest rates (near 7 percent for the 10-year government issue) make it impossible for states to survive without bankruptcy, a bailout or financial ruin.

 
Policy failures
 
In times like today, when deleveraging is slowing economic activity, government should adopt policies that promote the private sector, because it is the private sector, not government, that is the engine of economic growth. Unfortunately, the following federal policies currently are negatively impacting the private sector:

• Taxes:
Uncertainty surrounding tax policy causes the private sector to take less risk, which lowers investment and job creation. For the last several years, Congress has signaled that significant tax increases are just ahead (currently referred to as the “fiscal cliff” due to occur on Jan. 1, 2013), only to push them back at the last minute for another short period. Nevertheless, the uncertainty persists, and economic hesitancy pervades.
 
• Corporate cash: America’s multinational corporations are flush with cash, and while the politicians chide them for not putting it to work at home, it is their very policies that are to blame. Sixty percent of that corporate stash is held offshore, and it won’t come home because, if it does, 35 percent of it will disappear in taxation. Policies that encourage the return of that cash and its investment at home would spur job creation and economic growth.

• Corporate tax rate:
Having one of the highest corporate tax rates in the world discourages investment at home and makes investment elsewhere more fruitful. Corporate taxes are paid by consumers via higher prices.

• Energy policy: 
Cheap energy is the No. 1 requirement for robust economic growth. Current policies appear to be designed to raise energy prices to spur the development of government selected industries. The result is great waste (e.g. Solyndra) and significantly reduced economic growth.

• Taxmageddon:
The U.S. has a joke for a tax code. Talk about a Rube Goldberg! High, and threatened increased taxes on capital and investment just discourage economic growth. The tax code needs to be thrown out in favor of a broad-based, simple, and fair system.

• The financial system:
Scandal after scandal show how pervasive lawlessness is among the world’s “too big to fail” institutions. So far, no U.S. banker has gone to jail, nor trial, nor has anyone been indicted. Regulatory policy encourages moral hazard (excessive risk taking backed by implicit taxpayer bailouts) and discourages lending to the private sector. All of this reduces economic growth.
 
 

Investing in a deleveraging world 

 
For investors, the markets will continue to show volatility, with market up-drafts occurring when there is a perception of a policy change. For example, the recent hope generated by the late June “European Summit” caused a large rally in the equity markets, as will the hoped for move by the Fed toward more stimulus when and if it occurs. Down-drafts occur when poor economic data cross the tape.
 
Implications for Nevada
 
The policy prescription doesn’t end at the federal level. It is also relevant at the state and even local levels. Nevada has been challenged to attract new businesses now that gaming is widespread.The tax system in Nevada could be such a strength, especially when compared to what is going on in California. CNBC ranks Nevada 18 in “Business Friendliness,” but 30 in “Cost of Business.” Two things are critical: 1) The Legislature must stop threatening new business taxation every two years when it meets. The uncertainty this breeds prevents businesses from relocating here.

2) Policymakers must identify those businesses that would benefit from such a philosophy. There might be several categories that would so benefit, but one immediately comes to mind (maybe because I have worked in it all my life) — financial and intangible asset firms. This category includes managers of investments, hedge funds, trusts, patents and trademarks, insurance companies and services, banking and subsidiary finance companies. While these firms are usually small, their salary levels generally are high. A University of Nevada, Reno study indicates that salaries in these firms average $88,000, twice the state’s average.

Jon Ralston, a political columnist and host of a daily political commentary show seen locally, recently criticized the Apple move, saying that they will grow “astronomical profits” but that the state won’t benefit much because the number of jobs is small. But its move, along with those of Microsoft (which now employs several hundred), Intuit (also a large employer), Oracle and others, appears to recognize that Nevada, indeed, has something to offer now. If the state attracts enough of these companies, there will be plenty of tax revenue generated. The state should play to its current strengths and make sure its policies protect and nurture those strengths.

 
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521.
Ph: (775) 284-7778.
 

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