September 23, 2013

Enjoy the party, but beware of the hangover 09.22.2013

Posted in taxes, Uncategorized, Wall Street tagged , at 7:07 PM by Robert Barone

Despite what was widely viewed as a weak employment report in early September, the U.S. economy appears to be on solid footing. Both ISM manufacturing and nonmanufacturing indexes for August were strong, with the nonmanufacturing index setting a record high. Initial unemployment claims have been in a steady and steep downtrend since 2010. Job openings in the private sector are higher than at any time since 2008, and employers complain they cannot find qualified candidates. So, while we aren’t quite in a boom, put any thoughts of recession on the back burner. But, make no mistake, inflation lies ahead.

Political gridlock

The No. 1 reason for this inflation forecast is the inability of governments at all levels, but especially the federal government, to rein in spending. At least once each year, we are treated to a confrontation between left and right over budgeting, spending and the deficit. But, nothing is ever resolved — the can is just kicked further down the road. The table above uses Congressional Budget Office baseline forecasts, which are quite optimistic. The table displays the baked-in growth in federal spending as a percentage of total economic output (gross domestic product).

09.22.2013 ART

Sources: Heritage Foundation; Jeffrey Gundlach/Doubleline Funds; U.S. Debt Clock website; Congressional Budget Office

2020 is only six years away, and 2030 but 16. From 1959-2008, the average revenue of the federal government as a percentage of GDP was 18.1 percent. For 2013, year to date, it is 16.9 percent. To balance the budget in the next six years, current tax rates must rise 43 percent. To balance it by 2030, those tax rates have to rise 59 percent. And these data points come from optimistic CBO forecasts. In an economy that the Fed considers so sluggish so as to not start its “taper” process, it is unlikely that taxes can be raised to these levels. Furthermore, the middle class, which pays most of the taxes, is rapidly shrinking due to the stealth inflation that has sapped their purchasing power. And, of course, the political chasm and resulting gridlock between the left and right has made addressing the automatic growth in federal spending essentially impossible.

The big story of the week was the fact that the Fed decided to keep the pedal to the metal (the “no taper” announcement) and the rapid growth in its balance sheet, which, essentially, is the creation of money that the banking system can lend several times over, continues unabated at $85 billion per month. Wall Street, the main receptor of the Fed’s largesse, sent the equity averages to all-time highs. But the Fed’s credibility took a hit, especially since the chairman telegraphed the “taper” way back in May. The very next day (Thursday), both jobless claims and existing home sales showed a much stronger underlying economy than expected. The markets now are questioning the Fed’s ability to even read the underlying trends.

Since the financial crisis, the Fed’s balance sheet has grown about $3 trillion, from about $800 billion to more than $3.6 trillion. During that same time period, U.S. Treasury debt outstanding has grown from $10 trillion to $17 trillion. In effect, the Fed has “monetized” 43 percent of the new debt over this period. Given the growth in automatic federal spending, it appears that monetizing the debt will be a major function of the Fed.


• The economy is stronger than the Fed thinks and the unemployment report intimated.

• This is the first Fed in modern history to advocate higher rates of inflation (2.5 percent). Don’t be fooled; do you think that when the official CPI reaches 2.5 percent, it will automatically stop there because that is the Fed’s target?

• The rapid growth in automatic federal spending over the next few years will require the Fed to continue its large-scale asset purchases, just to support the Treasury’s need to issue debt and to keep interest rates down. Otherwise, the cost of interest alone will overwhelm the federal budget. The alternative, much higher taxation, is not politically viable.

• Ultimately, the dollar will weaken as the world recognizes that dollar debasement is occurring. Note that on the day of the Fed “no taper” announcement, gold rose by $55 an ounce. Market players aren’t stupid.

• Meanwhile, enjoy the continuation of the Wall Street party. But, beware of the inflation hangover.

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, Matt Marcewicz 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.

February 8, 2012

Avoiding The Austerity Death Spiral

Posted in bail out, Banking, Bankruptcy, Ben Bernanke, Big Banks, Economy, Federal Reserve, Finance, government, investment advisor, investment banking, investments, Senate Banking Committee, taxes, Unemployment tagged , , , , , , , , , , , , , , , , , at 8:19 PM by Robert Barone

Over the past four years, the slow creep of government into the private sector has become a gallop.  Unfortunately, a high level of structural unemployment is the unintended consequence of social engineering, picking winners, over-taxing and over-regulating every aspect of the business process.

The conventional wisdom is that a balanced budget will be a magic solution to the sluggish economy and the employment situation, but if it is done with just austerity and tax hikes but without relief from an overbearing set of governments on the business sector, what we will get is an “austerity death spiral.”  Federal Reserve Chairman Ben Bernanke said as much to the Senate Banking Committee on Tuesday.

Intervention is the Norm

We now live in a world where government intervention in the business process is expected.  When any sort of economic issue arises, government is now expected to fix it.

  • Financial institutions in trouble?  No problem – the taxpayers, via the government are expected to bail them out!
  • Domestic auto companies historically made awful decisions around retiree medical and pension issues and, as a result, can’t compete and are staggering toward bankruptcy.  Again, no problem.  Ask the government to shore them up, even if it means trampling on bondholder contract rights like in the General Motors case.
  • Some homeowners can’t, and others don’t want to make their mortgage payments.  That’s easy.  Ask the government to intervene, stop or slow the foreclosure process, and, perhaps, even require the lenders to reduce principal balances! This deal is in the works now with the government prepared to offer big lenders like Citigroup, Bank of America, Wells Fargo and JPMorgan Chase money to offset losses on short sales.

The markets now expect intervention.  When the government intervenes in an economic issue, the markets rise.  If the government doesn’t, it falls precipitously. On September 29, 2008, the Dow Jones Industrial Average (DJIA) fell 778 points when Congress failed to pass the initial TARP legislation; From the time QE1 began in November, 2008 until it ended in March, 2010, the DJIA rose 28% or  2,378 points.

QE2 elicited a similar market response, 1,199 points (10.7%) from November, 2010 to June, 2011, even more if you go back to August when Bernanke articulated the strategy in Jackson Hole, Wyo.

In late November, 2011, on the day when the Fed gave unlimited swap lines to the European Central Bank (ECB), the DJIA rose 490 points; it rose 337 points just before Christmas when the ECB opened its lending facility to 540+ European banks.

I suspect we will see similar market reaction if the Fed goes through with its hinted at QE3.

Unintended Consequences

Unfortunately, nearly every government intervention carries with it unintended consequences, and, if such interventions interfere with the free market processes, they have long-term negative implications on economic growth. Recent examples in the U.S. include the Keystone Pipeline and the National Labor Relations Board’s attempt to block Boeing from opening a plant in South Carolina.

Nearly every economic malady that exists today is directly traceable to the unintended consequences of government interference in the economic process or via its attempt at social engineering:

  • Sub-prime and housing crisis:  It is widely recognized that this was caused by three concurrent factors: 1) an extended period of low interest rates engineered by Greenspan’s and Bernanke’s Fed; 2) the social engineering goals of the Community Reinvestment Act (CRA); 3) the political and monetary aspirations of Fannie Mae and Freddie Mac executives and sponsors;
  • Social Security and Medicare unfunded liabilities: As the baby boomer generation reaches retirement age, unfunded liabilities will increase by more than $3.5 trillion each year.  To show how absurd this is, the payroll tax reduction, in effect since January 1, 2011, and currently an issue in the Congress, simply puts the Social Security system ever deeper into debt that cannot be repaid without hugely inflated dollars;
  • Unfunded pension liabilities:  While some private sector corporations have unfunded pension liability issues, the bulk of the problem lies at the local, state and federal levels;
  • High structural unemployment: As alluded to earlier, impediments to business from all levels of government, but especially from the federal government, are a huge issue.  Recent legislation, including Sarbanes-Oxley, Dodd-Frank, and Obamacare, is crushing small business.  In addition, business must be confident that the future environment will be friendly.  So, the notion of a “temporary” tax reduction doesn’t reduce business uncertainty, as businesses invest for the long-term.

This last item is particularly poignant.  In a three part op-ed series published by Bloomberg in mid-January, Carl Pope, former chairman of the Sierra Club, bemoans America’s loss of manufacturing jobs.  “It’s not the wages, stupid!”, he says.  If wages were key, how is it that Germany, where wages are higher and unions stronger, enjoys a growing manufacturing base?

For the auto industry, which in 1998 had over 70% of the U.S. domestic auto market but now has 44%, it was the health care and pension costs of its retirees that caused the industry’s economic crisis, he says.  Since the turn of the century, America’s manufacturing base has shrunk by one-third, not because of wages, which are similar to wages paid in the rest of the world, but the lack of support or even outright hostility on the part of government.  (When even the Sierra Club recognizes that government is choking free enterprise, the issue must be terribly obvious!)

February 6, 2009


Posted in Banking, Finance, investments, Uncategorized tagged , , , , , , , , , , , , , , , at 11:56 PM by Robert Barone

Brief Remarks of Robert Barone to the EDAWN Directions Conference

Reno, Nevada

Friday, February 6, 2009

Last year, I stood before this conference and indicated that two things needed to be done for the general U.S. economy: 1) stop the downward spiral in housing prices by giving a 15% tax credit to all primary home purchases; and 2) address the irrationality in the “mark to market” accounting rules which have artificially made the capital crisis in our financial system much worse than it needed to be.

Now that Bear Stearns, Lehman Bros., Fannie Mae, Freddie Mac, Washington Mutual, Merrill Lynch, and Wachovia Bank have failed, and AIG, Citibank and Bank of America are all but zombies (i.e., ghosts of their former selfs), these two actions are finally being considered.

I want to very briefly give you 4 forecasts which, if you invite me back next year, we can analyze when we meet: 1) our RE markets will still be a problem, although the price deterioration should have stopped by then; 2) gaming revenue will be relatively flat, perhaps up a smidge; 3) the federal budget deficit will be more than $1 trillion; 4) and the price of gold will be higher than it is today.

Because you will undoubtedly hear from our panelists all of the reasons that our economy is in the fix that it is in, I am going to take us in some other directions. “Directions” – that’s a good word – and it happens to be the name of our conference. From its name, we can deduce that it is the intent of this meeting to figure out the directions that are available to us as a business community.

In the 1930s Depression, leaders in this state (Nevada) had the vision to give the state a new direction – they legalized gambling, and that single decision has sustained this state and has led to 75 years of prosperity here. Today, we need to be equally bold in guaranteeing our future prosperity. I have three such proposals. But before I give you the specifics, I want to say that if we don’t stop looking to Washington D.C. to solve our problems, they will never go away. In yesterday’s Reno Gazette, there was a story that indicated that state aid in the so called Stimulus plan required that the state raise an additional $500 million. Clearly, the folks in D.C. don’t understand that when the people don’t have money, you can’t raise taxes and have to cut spending.

Ok – let me get specific. The first proposal is short-term in nature and can potentially bring huge amounts of cash to our state coffers. The other two are longer-term in nature. Here they are:

1) Accept the Yucca Mountain nuclear waste repository on the condition that we get paid handsomely by those asking us to house their nuclear waste. Within a few years, this can solve our state’s budget crisis.

2) The state of California is, itself, a zombie. They believe that the only way to solve their budget woes is through revenue enhancement; translated, that means higher taxes. Silicon Valley folks would love to bring their businesses to Nevada, and California is driving them out. Their chief complaint about our state is that our University System doesn’t produce enough graduates with the skill sets that they need. So, let’s take some of the Yucca Mountain revenue and build such a capability in our education system.

3) Just as our 1930’s leaders recognized that U.S. consumers were hungry for gaming, we should recognize that today, U.S. consumers are hungry for affordable and clean energy. Nevada has an abundance of sunshine, wind and geothermal, and we can use those renewable resources to build renewable energy power stations. We also have an abundance of open space and rural communities that would gladly accept clean coal, nuclear power plants, and new oil refineries, and relish the jobs these industries would create.

These are the directions I believe we should take.

Robert Barone is a Managing Principal of Ancora West Advisors LLC a SEC Registered Investment Advisor and a Registered Principal of Ancora Securities, Inc. (Member FINRA/SIPC).

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II. A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778