Investing for Sustainable Gains

So, how do we spend our time, collectively, as a nation?  What do we do?

For the ears of babes, we find this nugget of statistical wisdom in a 2009 children’s book:

“If America Were a Village” (by David J. Smith):

(Imagine the United States is a village with a population of 100. What would it look like, based on (carefully sourced) national statistics?)

“More than one quarter of the inhabitants of our village - 27 in all - attend school.”

“47 are employed… 18 are in professions… 12 are in sales… 7 in service occupations… 5 work in construction and repair… 5 work in manufacturing, farming and the transportation of goods.”

“There are 5 people in the village who want to work but can’t find jobs.”

“The remaining 21 people don’t work: 15 are retired, while 6 are not looking for work or are unable to work. Of the 6, 1 person is in prison or jail. (One other, who may be working, is on parole from prison.)”

So…  what is wrong with this picture?

First, I don’t see where the military workers went… but nevermind that, maybe they are in “service occupations”, which lists “1 in firefighting and law enforcement”.

Second, I don’t see where the babies and children not in school went.

But perhaps most shocking to me is that less than half the population is working, and evidently the population (on balance) also spends 27% of its lifetime just on going to school!

It seems to me that standards of living could be improved for the whole population if the workforce were increased (producing more goods and services for all to exchange), and if the educational system were streamlined (less years in school, more years being productive… maybe some years working for experience while also going to school?).  It also seems that the “sales” population (1 in 4 workers? really?) is too high. Imagine if we had half as many sales clerks and twice as many manufacturing workers!  Or if we needed only 4 construction workers (not 5) and put them to work making other things?  Also, some of the “professionals” may not really be needed (see below)… that’s another place where we could actually produce more for each other, instead of most workers just pushing papers and staffing cash registers, while only a few workers actually produce.

One worry is that the number of elderly retirees/nonworkers is likely to increase in proportion to the population. We will have to reduce the proportion of  “workers”, or the number of students, just to make room for the retirees in the “pie chart”.

Also, “One person has more than 30 percent of the wealth.” and with 4 more it’s also true that “5 people have more than half of all the wealth” … “while the 60 poorest people share only about 4 percent of the wealth.”  That just isn’t right. Although, to be fair, some of those 5 saved like mad while they were working and have earned their retirements.

For the detail oriented:

The 27 in schools can be broken down as follows: 3 are in preschool/kindergarten, 12 in elementary school, 6 in high school and 6 in college/other training.  (If 12 are in Elementary, then I believe 9, not 3, should be listed as being in preschool/kindergarten, since children typically enter Kindergarten at age 5, whereas elementary school K-6 is 7 years. 9 is about 5/7 of 12.)

The 18 in professions break down as: 4 in management, 3 in education/training/library, 2 in health care, 2 in finance, 1 in computer tech, 1 in architecture/engineering, 5 in science/law/social service/arts (not that these all have equal social value…)

The 7 in service occupations break down as: 2 in food preparation (cooks), 2 in cleaning/maintenance of buildings and grounds, 1 in health care support, 1 in firefighting/law enforcement, and 1 in personal care & services (hairstylists, etc.).

I suspect that if we had 1 less each in management, finance, health care and law, no one would notice (especially if we simplified our over-complicated legal, financial and health care systems).  That makes room to support more productive workers and/or more retirees…

A post today on CalculatedRisk caught my eye:  What might the Fed do?  There is a lot of anxiety about the future of the economy,  leading to wondering about whether the Fed may extend the current period of low short-term interest rates, or even buy down longer-term Treasury bonds to reduce rates further.

Implicit behind this is the idea that lower interest rates stimulate the economy.  There’s a lot of history behind the approach, but does it still hold true in today’s environment?  I am not so sure.

Low rates stimulate borrowing… but today we have few creditworthy borrowers with an appetite for additional credit. Instead we have debtors scrambling to get out of debt, unemployed people needing to live off savings, and a lot of people in and near retirement who are trying to figure out how they will generate enough income to get by.  I can see lower rates allowing debtors to reduce their interest costs, but savers then need to “save more” in order to maintain their income levels… or they need to cut spending.

Low rates encourage the government to borrow… but is that really the way to generate an economic recovery?  At present that just scares taxpaying consumers into worrying about future taxes… so they save more.

Low rates stimulate tangible investment… but today we have a surplus of capacity in everything: housing, commercial real estate, industrial production capability.

Low rates tend to make stocks more attractive than bonds… but do we want another stock market bubble?

It seems to me that what we need are new industries, new lines of work to employ the current surplus workforce and provide new demand for existing production capability. But we probably want those to be financed primarily out of equity capital rather than debt!

And it seems to me that we want to encourage saving and productive investment, by allowing those actions to generate reasonable rates of return — without frenzied capital-gains bubbles.

For every debtor, there is a creditor…

I have read a lot of concern about the debt burdens of various nations, including not just government debt but also corporate, private, etc.  Mortgages, car loans, credit cards…  But, for every debtor, there must be a creditor.  Who are all the creditors?  And, with so much unsustainable debt, why is there so much credit?  Why have so many lent so much?

Did we try to sell the “New American Dream” of retirement to too many people?  Is there too much “retirement savings” chasing too few potential borrowers?  Can the economy support so many millions of non-working retiree creditors, as we will soon have?

Or is the distribution of wealth too skewed, with too many owing too much to too few?  Is the debt burden just another tax on the young and productive, transferring wealth to the aged and/or unproductive?

As for the creditors:  Why are they still trying to lend?  What happens when they stop trying?  Which borrowers will be able to pay off their debts, and which will default?

Unsustainably large sectors of the economy are likely to contract during a major economic upheaval (as we anticipate may happen!).  It’s fairly widely discussed that financials have overgrown their healthy natural bounds (40% of S&P 500 profits is a bit large for a sector that just reallocates capital?).  A similar complaint seems reasonable for the health care sector, where it appears that a large proportion of the spending (late in one’s life) just goes to keep unproductive retirees from dying until the last affordable moment.  Health Care is also an overgrown sector, we find from the ‘net, apparently from the HHS Medicare/Medicaid Summaries from 2003:

“Health spending in the United States has grown rapidly over the past few decades. From $27 billion in 1960, it grew to $888 billion in 1993, increasing at an average rate of more than 11 percent annually. This strong growth boosted health care’s role in the overall economy, with health expenditures rising from 5.1 percent to 13.4 percent of the gross domestic product (GDP) between 1960 and 1993.

Between 1993 and 1999, however, strong growth trends in health care spending subsided. Over this period health spending rose at a 5-percent average annual rate to reach $1.2 trillion in 1999. The share of GDP going to health care stabilized, with the 1999 share measured at 13.2 percent. This stabilization reflected the nexus of several factors: the movement of most workers insured for health care through employer-sponsored plans to lower-cost managed care; low general and medical-specific inflation; excess capacity among some health service providers, which boosted competition and drove down prices; and GDP growth that matched slow health spending growth.

In 2000 and 2001, growth picked up again, increasing 7.4 percent and 8.7 percent, respectively, to $1.4 trillion in 2001. Health spending as a share of GDP increased sharply from 13.3 percent in 2000 to 14.4 percent in 2001, as strong growth in health spending outpaced economy-wide growth. For the 283 million people residing in the United States, the average expenditure for health care in 2001 was $5,035 per person.”

Another useful dataset is at a Kaiser Family Foundation link.  Health care at 15.2% of GDP in 2003 vs. 7.0% of GDP in 1970, 8.8% in 1980, and 11.9% in 1990. And we can be reasonably confident that health care costs have outstripped inflation and GDP growth since 2003 as well.

Now, as a citizen and a taxpayer, I want to see the health care sector become more productive and efficient. As an investor, though, “productive” and “efficient” (from the consumer perspective) tend to suggest “reduced profits” (from the shareholder perspective).  I think this is good, because it will free up resources to do better things… or at least free up resources to actually provide decent care to the millions of retiring boomers.

But it looks to me as though the “health care growth to take care of retiring boomers” trend may have played out.  I don’t think this sector (as a whole) is a sustainable-gains sort of investment.  Although I will be keeping my eyes open for  companies leading the way to “productive” and “efficient” healthcare!

Both JNK and HYG cratered about an hour ahead of the SP500.

Also, the only thing preventing today from getting a “Hindenburg Omen” warning is that there were not enough new highs.  But a significant number of stocks (200+ in bothy NYSE and NASDAQ) hit new 52-week lows, suggesting a soft underbelly in the markets.

The imploding charts where stops were run and no underlying bids were found bodes ill for trading in the near future.  I worry that the sheer amount of tradeable information released in the panic today is going to lead to a lot of aggressive moves tomorrow.

Here’s what some of the DOW components (including the alleged P&G “fat finger”) did.  Note that they were all in deep doo-doo before the market cracked and fell apart.  There may have been one particular trade that broke through the bids on P&G (which got hit worst of the group in the chart), but this was a systemic issue and not a single idiot at a terminal.

(1) Verb:  To review something and edit it so it “looks better”… but is no longer factual.

(2) Verb:  When a company’s auditor permits false and fraudulent accounting or reporting.

I spotted this quote over on The Big Picture today, and thought it apropos given the subtitle of this blog (”making the most of time and treasure”):

“Riches do not consist in the possession of treasures but in the use made of them.” —Napoleon Bonaparte

(Whatever one thinks of Napoleon, he certainly knew something about both treasure and many of its uses!)

From this perspective, much of Wall Street, though it has accumulated “treasure”, knows nothing of “riches”. Money not responsibly invested is wasted wealth, as is the labor (”time”) of those involved.

It is also worth pointing out that banks do not own their money.  They merely borrow it from their depositors and other creditors.  If they accumulate riches (i.e. siphoning profits off the spread between their borrowing costs and their lending rates), it is only because they are better at making “use” of your treasure than you are!

DOLETA reports 414,657 actual unemployment claims for the week ending April 3, and puts that at 460,000 seasonally adjusted, an increase of 18,000 from the prior week. The media spin on this is negative. BUT… As shown below, this is actually a very favorable weekly claims report.  Last week the claims number was 41% of the way up from the low values of 2006-2007 to the high value of 2009 *for this week*; this week it is only 31% of the way up. The claims data continue to trend towards the “healthy” market level.

I do not know where the Department of Labor gets its seasonal adjustment factors from, but the fact is that there was a surge in claims during this time of year (an increase of about 30,000, generally this exact week, sometimes 1 week earlier) in each of the past 4 years.  Their seasonal adjustment factor doesn’t seem to be filtering that out correctly.

Related Links and The Chart:

Department of Labor Weekly Unemployment Claims for Week Ending April 3
Calculated Risk

Hoocoodanode (Calculated Risk Comment Thread)

Per a Bloomberg article , a “Labor Department analyst” (don’t these people have names?) reportedly said something to the effect that (don’t these people get direct quotes?): “Easter is a particularly “difficult” to adjust for seasonal factors because it’s a floating holiday that doesn’t come at the same time each year, the government analyst said. Additionally, a state holiday in California on March 31 also complicated the tabulation of the data, he said.”

I think the chart above is pretty clear and doesn’t need much media obfuscation!

The last two weeks of unemployment claims data have shown not only the usual seasonal lull in new claims, but also shown a trend downward.  We are still far from a healthy employment market.  If the current downward trend continues at the current rate, we might expect a healthy employment market, with meaningful jobs growth, by the end of the year.  (This is an extrapolation of the current trend in the “Claims Oscillator” on the chart below.)  On the other hand, with Congressional stimulus and Federal Reserve credit injections waning, banks still crippled, and few strong growth industries…

I saw some comments over on CalculatedRisk which compel me to explain how the Federal Reserve actually works in reality. It is different from the Fed’s self-generated mythology - and also from the skeptics’ mythology.

The Fed will have you believe that they “set interest rates”.  The skeptics will say no, the market sets rates, and the Fed merely follows and claims victory.

Neither is true, and yet both are true.  As usual, look not at what they say, watch what they do, and follow the money!  What does the Federal Reserve actually do?  They buy and sell debt, and they talk a lot.  But it is by means of the first activity that the Federal Reserve is able to manipulate the total amount of credit (what we now use as “money”) that is available in the economy. It does this by expanding or contracting its “balance sheet”.  For every security stored inside the Fed’s balance sheet … and paying interest to the Treasury … after the Fed takes its cut … someone else has a large amount of credit to spend on something.  The Fed creates credit “ex nihilo” - out of nothing.  A mighty power, which is why the Fed Chairman is frequently described as the most powerful man in the nation.

Those claiming that the Fed is a fictitious organization often point out that short term interest rates lead the Federal Reserve’s policy target rate. The market leads and then the Fed follows, right?  Well, the Fed does have to react when short term rates pressure the bounds of the policy target, because otherwise rates would go where the Fed doesn’t want them to go. But ask yourselves — how many folks spend thousands of hours each year trying to figure out where the Fed wants rates to go, and get there first? The market is doing the Fed’s bidding because that’s where the money is. What actually happens is that the Fed telegraphs to the market which way the rate is about to go — or the market has figured out where the Fed will be telegraphing, and has front-run them, which amounts to the same thing but yields more profit for the banksters.

Now, if the Fed can convince the market where it wants the market to go, and the market goes there, it’s a lot less work for the Fed.  And thus a lot less expensive. But there are times when the Fed has to take the market by the horns and implement massive adjustments.  This is part of what happened in 2008-2009. Sometimes the Fed dances with the market, and sometimes the Fed picks the market up bodily and shoves it into place…

But back to the standard operating procedure: the main tool is the policy press release issued at each Fed meeting, which typically reveals (in a few words) the Fed’s outlook for short-term rates. Secondary tools are the minutes released between the meetings, the “Beige Book” economic analysis, and also the public speeches which are frequently given by the various Fed members.  Each of these helps to set the market’s expectations of future policy.  Conversely, the market also communicates with the Fed, by way of current interest rate pressures (relative to the current Fed target rate) and prices in the rate futures markets.

Now, which is more powerful?  The market would always go where the Fed leads it, unless it believed the Fed were fully able to implement its targets.  On the one side, the Fed’s ability to drain credit from the market (by selling assets on its balance sheet and siphoning cash out of the system) is a potent, but not omnipotent, lever for raising interest rates.  By shrinking the supply of short-term credit, the Fed can fully offset private-sector increases in credit, and force short-term rates upwards.  This generally moves the long-term rates up as well — who wants to lend long when short rates are paying more, and less risky?  But sometimes the market is in full fraudulent bubble mode, in which case the Fed can force up short-term rates, but long-term lending supply doesn’t respond immediately, and rates fail to respond — as Greenspan’s “conundrum” showed in the 2004-2007 tightening cycle.

On the other side, by expanding the supply of short term credit, the Fed can fully offset just about any private-sector decrease in credit, and force rates downwards. And again, drops in short rates tend to result in drops in long rates, as yield-seeking borrowers are forced to make longer commitments (and thus take on more inflation risk).  This again can fail (or at least take a long time) when the market is in full panic mode, in which case the Fed can also force down long-term rates by purchasing long-term securities.  (But as Bernanke is now experiencing, even after buying up over $1 trillion in fraudulent mortgage securities and flooding the banks with enough cash to give nearly $3,000 to every man-woman-and-child legally in the country, the Fed can force short term rates to zero, and it can pull 30-year rates under 5%, but it still can’t make  creditworthy borrowers out of overindebted individuals and institutions, nor can it make others lend for 30 years in a climate bordering on hysteria over long-term fiscal/policy stability questions…)

So which is more powerful?  From 2004-2008 we saw the market bubble with low long-term rates, despite (belated) Fed efforts to raise rates.  In 2008-2009 we saw the market panic with a total credit freeze (infinite rates - no credit at any price!) in many parts of the market. But we also saw the Fed go thermonuclear and force short rates to zero and long rates to record lows.  So in the short term, the Fed is more powerful.

But in the long term, the actions of the Fed have economic and political consequences. Buying up Treasuries is seen as printing money and enabling Congressional waste.  Buying up mortgage securities is not only probably illegal (based on a tight reading of the Federal Reserve act and the legal technicality that Fannie & Freddie debt is not “full faith and credit” debt of the U.S.), but also has political consequences as people begin to realize that fraudulent lending is “crime that pays”.  Some of those political consequences lead to “Audit the Fed” movements and other political pressures, and those in turn remind us that in the end, the Federal Reserve is only as powerful as Congress allows it to be.

But remember to watch what the Fed actually does!  It’s the Temporary and Permanent Open Market Operations that matter!  And the alphabet soup of lending programs.

And finally:  A more transparent Fed would go a long way toward cleaning up the Augean Stables of American Finance, and while that would be painful for us all in the short term, in the long term, accurate and transparent national accounting is vital to restore investor confidence in security of prinicipal and reasonable rates of return, on investments one can be proud of.