October 21, 2013

If only Congress would get out of the economy’s way

Posted in Uncategorized tagged , , , at 8:37 PM by Robert Barone

A few things became clearer during the recently ended federal government “shutdown” and debt ceiling crisis:

1. Our political system has deteriorated to the point where each side of the political spectrum is willing to push to the very brink of disaster before even the most basic remedial action is taken.

2. The “level” of the debt is really not the issue; it is the growth rate of that debt relative to the growth of the economy.

These issues raise the level of uncertainty in the economy and therefore stymie private-sector growth and job creation.

Spending projections

All credible projections of federal spending show that Social Security, Medicare/Medicaid and other social spending programs will explode in the coming years unless Congress and the president do something to fix the situation.

In 1982, projections were that Social Security faced insolvency by 1990. But, that didn’t happen because President Reagan and House Speaker Tip O’Neill reached a compromise and a solutionthat kept the Social Security program viable for a while longer.

To the brink

When Congress and the president confront the spending issues, their choices will be to raise taxes, reduce benefits or, via compromise, some combination of the two.

But we know that they won’t act until the spending issues become a recognizable crisis and/or their political futures require that they act. This is most likely to come in the form of “invisible hand” economic actions wherein the dollar drops in value relative to other currencies and interest rates rise, as the international community relies less and less on the dollar as the world’s reserve currency.

China and Russia are becoming more and more vocal and active in seeking alternatives to the dollar in world trade. If the necessary spending controls aren’t soon put in place, the U.S. economy could lose its premier status. Don’t underestimate the importance of the “reserve currency” status in the economic growth equation.

The reality of the debt

One argument in the current bickering is that the country will never be able to repay the $17 trillion of debt it has accumulated. From an economic point of view, the debt level itself isn’t the issue. The issue is how fast that debt is growing and its cost.

Unlike an individual whose debts all come due upon death(either the estate pays the debt off or the lender(s) writes it off), a country doesn’t die (without a revolution). As long as the growth rate of the debt is less than the growth rate of the economy, and as long as interest rates remain reasonable, the debt will never be expected to be repaid.

From this point of view, the most significant single statistic is the debt’s relationship to GDP. The concept is similar to that of an application for a mortgage. The borrower needs a reasonable “debt payment/income ratio” to qualify. The more pre-existing debt one has, and the more of one’s income it takes to service that debt, the less credit worthy the individual becomes.

Debt/GDP history

After World War II, the debt/GDP ratio was 120 percent. Why wasn’t it a disaster then? The answer: 1) the war had ended and spending was reduced; and 2) the economy grew faster than the debt.

By 1974, the debt/GDP ratio had fallen to 32 percent. It rose after that to 66 percent in 1996 after the recession of the early ’90s, but fell to 56 percent during the strong economic growth years of the late ’90s and the spending-control emphasis of the Congress (which was accepted and then embraced by President Bill Clinton).

By 2008, as a result of the 2001 recession and debt growth outpacing economic growth during the Bush presidency, the ratio rose to 70 percent. Then came the financial crisis and the recession with weak economic growth in its aftermath. The debt/GDP ratio now stands at more than 100 percent, a level that makes the international community nervous.

Conclusion

There are two key concepts here: 1) controlling the size of the fiscal deficit to control the growth rate of the debt (this implies confronting the growth rate of the social programs); and 2) growing the economy fast enough to accommodate a rising level of debt.

Spending, entitlement growth, the growth of the debt and economic growth are all intertwined. Since the spending issues were taken off the table in this week’s debt ceiling bill, the only chance at avoiding a true debt crisis is for the economy to grow.

The so-called “resolution” reopens the government only through Jan. 15 and increases the debt ceiling only until Feb. 7. Businesses are asking, “Are we going to relive this debacle all over again in three months?”

Such uncertainty clearly shows up in all of the business surveys as holding back economic growth and job creation. For everyone’s benefit, it behooves Washington to put some degree of certainty back into the business markets, at least for a long-enough time period to allow a return on new capital deployment.

The longer-term question is whether or not federal spending growth will allow the debt/GDP ratio to decline. If it does, then the fiscal issues in Washington, D.C., will disappear, just as they did post-World War II.

Unfortunately, the current way the government runs almost guarantees that spending will continue to probe the limits of the debt/GDP ratio. If this doesn’t change, one might want to prepare for those “invisible hand” economic implications.

 

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.

 

 

Advertisements

August 19, 2013

The Fed’s Bizarro World

Posted in Banking, investments tagged , at 10:33 PM by Robert Barone

The Seinfeld TV comedy series (1989-1998) had a set of episodes, known as Jerry’s Bizarro World, where everything “normal” was turned upside down and inside out. The Fed seems to have accomplished something similar with its experimental Quantitative Easing (QE) policies.
For the first time in a long time, underlying economic fundamentals are turning positive. Ordinarily, this would be good news for investors. But in today’s upside down, topsy turvey, bizarre markets, “good” news is bad for investors. The blame for this is squarely on the Fed’s QE policies and similar policies adopted by other central bank mimes.

The Good News

In the labor markets, job openings continue to be hard to fill (JOLTS report), layoffs and firings are at levels not seen since ’07 (Initial Jobless Claims week of August 10), and Voluntary Quits (“Take This Job and Shove It”) are rising. The consumer appears to be holding her own (retail sales) and deleveraging appears to be on its last legs (rising credit card and auto debt). Europe looks like it has bottomed (positive Q2 GDP growth) and the news from China shows higher growth levels than penciled in by the pundits. Normally, such news would be accompanied by rising equity prices. But not this time. In the U.S., the U.K., Europe, and Japan, recent positive economic data has been met with equity market sell offs. On August 15th, the Dow Jones sold off 218 points despite 5 year lows in jobless claims, a continuation of positive retail sales trends, and high and rising home builder confidence, a good leading indicator of future home sales.
The table shows the performance of the world’s equity markets with activist central banks for the year until the Fed’s “tapering” announcement on May 22nd, and then from May 22nd to August 15th, the date of this writing. Note that until May 22nd, the markets with activist central banks performed quite well despite relatively stagnant economies, but after the “tapering” announcement, equity prices have been less than stellar. Normally, during the first signs of a change in policy toward tightening, what we find is both rising interest rates and rising stock prices because monetary policy tightening means a strengthening economy.

151442

The Bizarro World

David Patterson of Brandywine Trust Group, in an August 15 Wall Street Journal piece, opined that markets no longer move on fundamental economic data, but on anticipated Fed policy moves. In fact, it isn’t so much the policy change itself that moves the markets, but whether or not that change was more or less than anticipated (i.e., the 2nd derivative).
Patterson’s premise is that the market knows that the Fed is counting on the “wealth effect,” via a rise in equity prices, to have an impact on consumption, and anticipates and discounts Fed actions to achieve that “wealth effect.” If the Fed acts (or fails to act), and its actions (or lack thereof) disappoint market expectations, equity prices react negatively. As a result, because “good” fundamental economic data means a stronger economy and less need for monetary accommodation, we now have the bizarre world where “bad” fundamental economic news moves the markets higher, while “good” news does the opposite. That is, “bad” is now “good,” and “good” is “bad.” Patterson sums up the Fed’s Bizarro World as follows.
The process can at some point turn powerfully negative, if the monetary stimulus stops, or is expected to stop, or becomes ineffective, which it will if it is expected to become ineffective, because it is only effective based on what the market expects. (emphasis added)
There are no special attributes of wisdom that are automatically imparted to the Fed’s Chair at his/her swearing in ceremony. The non-traditional policies adopted by the Bernanke Fed, and mimicked by other major central banks, are experimental. Going in, they did not know what the unintended consequences would be. But now we are getting a glimpse. At this writing, we do not know how the Fed’s September decision about the “tapering” of its QE program will impact the equity markets. Will it disappoint, or not? But, what we do know is that in the Fed’s new bizarro world, whatever that decision may be, and whether it disappoints market expectations or not, market reaction will not be tied to economic reality.

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.

August 6, 2013

Stagflation Is Here: Today’s Unspoken Truth

Posted in Economy, Inflation tagged , at 7:02 PM by Robert Barone

By Robert Barone, Ph.D

“Stagflation” is a term coined in the ‘70s. It means high levels of inflation in a stagnant or sputtering economy. Sadly, while unrecognized by today’s media and political factions, Stagflation is a reality.

Ingrained Inflation
The following appears in the Federal Reserve’s (Fed) policy committee statement following the late July meetings:

[I]nflation between one and two years ahead is projected to be no more than a half percentage point above the committee’s 2 percent longer-run goal…

The fact that today’s Fed is actually espousing inflation is truly scary. Their traditional role is that of inflation fighter, not inflation enabler. Worse, the inflation measure used is significantly biased to the downside.

The accompanying table shows the impact of various levels of inflation over 10 and 20 year periods.

Dollars Needed to Purchase One 2013 Dollar in

Rate of Inflation 10 Years 20 Years
2.0% $1.22 $1.49
2.5% $1.28 $1.64
3.0% $1.34 $1.81
5.0% $1.63 $2.65
10.0% $2.59 $6.72

As seen from the table, even low rates of inflation lead to unacceptable results over time. But the 5% and especially the 10% scenarios are true wealth killers.

While the “official” CPI inflation rate appears low today, it is based on a flawed methodology, which, over time, has caused it to be close to meaningless as a measure of the cost of maintaining a standard of living. In 1983 and again in 1995/96, the calculation of the CPI was modified to reflect a much lower inflation rate. While this has saved the government a huge sum in entitlement costs, the recipients of such entitlements have suffered significant standard of living reductions (see the work of John Williams at Shadowstats.com and Ed Butowsky at Chapwood Investments for details on how the CPI understates true inflation).

Ed Butowsky and his firm, Chapwood Investments, regularly survey the top 500 items on which Americans spend their after tax dollars. According to Butowsky, “the CPI increase from 2008-2012 was a total of 10.2%, but our research has shown that for many cities, the cost of living increase was more than that for just 2012.” Look at the 10.0% row in the table to see the devastation that a continuation of this level of inflation will cause.

Stagnation
Inflation is bad enough, but it is worse when inflation is rapid and there is no economic growth. In July the “official” U.3 Unemployment Rate fell from 7.6% to 7.4%, not because there was a lot of job creation, but because of the way long-term discouraged workers are counted and because the labor force participation rate shrank to 63.4% from 63.5%. Had the labor force participation rate remained at the pre-financial crisis level (66%), the U.3 Unemployment Rate would be 11%! July’s U.6 Unemployment Rate, which recognizes the part-time issue, stands at 14%.

Non-farm payroll employment including both full-time and part-time jobs, is still two million below the ’08 peak. As played up on several blog sites (e.g. Zerohedge) and even in the mainstream media, of the 953,000 jobs created in 2013, 731,000 or 77% were part-time. Some blame this on the approaching full implementation of Obamacare. While proof is only by association, it appears that the part-time issue has worsened as the full implementation date draws near.

Stagflation
Inflation appears already ingrained with double digit rates common in most major metropolitan areas. With a biased CPI measurement, there is little media mention of rising prices. Unfortunately, both monetary and fiscal policies continue to promote higher inflation levels, while the economy continues to sputter, barely producing positive growth (if, indeed, even those numbers are to be believed). The labor market, the real measure of the country’s economic engine, continues in neutral, at best.

As in the 70s, today we have “stagflation.” Back then, political campaign buttons read “W.I.P.” – “Whip Inflation Now,” as the politicians recognized a need for action. Today, we are told that the labor markets are strengthening and that inflation is benign. Clearly there is little recognition of the stagflation issue and even less resolve to combat it.

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.