Author Archive

Break the Debt Cycle before it breaks us.

Tuesday, June 7th, 2011

The debt ceiling battle qualifies as a “Squid Sighting”.

It’s absolutely time to break the endless-increase-in-debt cycle.  It was time 7 years ago when the economy recovered from the dot-com crash. Several trillion dollars later, more waiting won’t improve the situation. It’s time to stop spending “more” and start spending “smarter”.The rate of debt increase since 2004, compared with the lack of corresponding sustainable GDP increase, strongly indicates that we’ve passed the point where additional debt yields worthwhile benefits to the nation (or world) as a whole. Whatever we’re borrowing for, it’s not worth it!

From a certain point on, more debt primarily helps the lenders (who get secured streams of long-term income), not the borrowers.  I think we passed that point a long time ago.  Now we’re at the point where even the lenders are starting to realize that more debt may not help them, because a loan to someone who can’t repay is money gone. Widespread default and insolvency is bad for everyone, and the banksters can’t shift the bad debts onto Uncle Sam anymore without risking losses.

I think the markets know this, particularly after watching Iceland, Ireland, Greece and Portugal.  The U.S. has the advantage of the reserve currency, but we also have a lot of national obligations not consolidated into the national budget.

What I see is that Wall Street isn’t nearly as worried about the debt ceiling per se, as they are about the total unwillingness of Washington to face reality in terms of eliminating the structural deficits and bringing Uncle Sam’s spending back in line with tax income.

Some examples:
(1) Gold and silver have risen a lot in the past year.  It’s not because those investors are worried that there will be a deflationary government shutdown! It’s because investors are worried that there will be an inflationary spiral, unless we break out of our current print-and-spend and/or borrow-and-spend paradigm.

(2) TIPS yields range from -0.5 to +1.8%, whereas historically TIPS have had yields in the 2-3% range.  The historical TIPS yields reflect the fact that historically bonds yield 3% above long-term inflation.  The current low yields say that the market sees bonds as unlikely to yield as much as inflation (-0.5% TIPS for 5 years) or at most 1.8% above inflation.

(3) In stark contrast to the above, the overall low Treasury yields and hoarding of cash by household and corporations both suggest a strong fear of deflation as well.

Some commentators view the fear of deflation and the fear of inflation as mutually exclusive opposites, but they aren’t. It’s possible to be afraid of both, because our economic circumstances suggest that one or the other are becoming increasingly inevitable. For a nation with its own currency, excess debt must inevitably be defaulted upon, or repaid only in devalued money. The one is deflationary and the other inflationary. At this point, for us to avoid one or the other may no longer be possible.

Some people claim that Uncle Sam can borrow a lot more, since “interest rates are still low now”.  But Greek, Irish and Portuguese rates were low, too — even as they borrowed too much. But the lending markets aren’t omniscient, and can have a change of heart in a heartbeat. For those nations, once the market woke up, the credit markets shut down and the sovereign borrowers were doomed. We have to avoid having that outcome here!
Here in the U.S., we’ve got to take the foot off the gas pedal of manic deficit spending. Ideally we want to coast the budget into balance, rather than having a hard stop (or a crash over the cliff). But the most important thing is to quit accelerating our indebtedness.

To “spend smarter”, we will need a lot of thoughtful reprioritization and structural reform in how the government taxes and spends.  But we absolutely have to stop borrowing money for no good reason.  If we borrow money, squander it, and never repay the principal, all we’re doing is feeding the financial sector a perpetual interest income stream, stripped every year out of our nation’s productive output!  Right now I don’t think there’s much, if anything, on the margins of the federal budget for which we really want to further enslave ourselves to the bondholders!

Stop Feeding The Squid!

Must-Read Article: Breaking the banksters’ framing

Monday, June 6th, 2011

From Michael Hudson by way of Naked Capitalism (also circulating via Mauldin’s newsletter):

Michael Hudson: Will Greece Let EU Central Bankers Destroy Democracy?

The majority of today’s financial discussions use bank-centric framing and terminology to discuss the situations facing the debtor nations (and debtor citizens and corporations).  However, there are two sides to every contract, and it’s clear that the borrowers are not exclusively to blame for their over-indebtedness, as a result of fraudulent inducements, bribes, and all manner of self-serving spin from the financiers.  Moreover, when the bankers’ “solutions” consist of (a) more debt for the over-indebted, and (b) taxpayer bailouts for the bankers when the over-indebted finally stop paying, it’s clear that the bankers are part of the problem, not part of the solution — literally!

So I like the article above because it re-frames the issues (with emphasis on Greece and Iceland) in terms of the more fundamental, classical economic issue:  how do we reorganize to optimize national output?  It most likely does not entail continuing to enable the lenders to live off the labors of others, at least not as much as they do now.

Quick implications for debtor nations and investors therein:  (1) Stop feeding the squid!  Get out of debt if you can, and don’t fund the banksters’ shenanigans with your “investments”.  (2) Prepare for higher interest rates due to defaults and devaluation-driven inflation. Obviously more thought will be needed here, but as in the 1970s, a simple stock-and-bond portfolio may result in serious losses after inflation.  Watch and learn from the other nations, before it comes to our own doorstep…

The Economy Needs an Overhaul, Not Just Tinkering

Monday, June 6th, 2011

Following last week’s abysmal economic reports, particularly the May Employment Situation Report, there’s a lot of hand-wringing among policymakers and economists.  Why isn’t the economy responding to the Fed’s low rates and QE2?  How can Washington do more about jobs without further worsening the already-too-high national deficit?

As in my prior post pointing out that the Fed could do a lot more than just setting rates and running QE2, I think Uncle Sam could also do a lot more than just throw money around.  But most of the people commenting seem to be locked into the two prevailing political dogmas, and don’t seem to be thinking creatively about the options.  It might take some leadership to break through the political logjam, but isn’t that what elected leaders are for???

Typical framing of the issue is highlighted in a recent post by DeLong – both parties appear to have “prioritized deficit cutting over job creation and full employment”.  However, like the Greek and Japanese economies, the problems with the U.S. economy are much deeper than “lack of jobs” vs. “excessive deficits”.  The problems are structural and we need an overhaul, not just numerical tinkering with budgets, tax rates and Fed policy parameters.

We need to step back a bit and ask what, as a nation, the United States is all about?

Viewed holistically, we are a nation of 300,000,000 people, of which some are working, some are too young or too old to work productively, and some could be working, but aren’t.  Right now, too few are working, more are becoming too old to work (though some are retiring before they should), and too many aren’t working who should be.

Of those who are working, too many are engaged in activities which don’t actually improve the nation as a whole.  We could probably create a national situation in which there was gainful employment for all who wanted it, but we need massive institutional reforms across much of the scope of government.

Among many examples, we might consider actions to (a) cut back on military and “homeland security” spending via institutional reforms, (b) reinvent the health-care delivery apparatus to streamline costs relative to outcomes, and (c) make it easier for the poor to get richer through hard work, while making it harder for the rich to get richer without working.

For (a), we ought to figure out why it costs $1,000,000/year to deploy a single combat soldier overseas, and cut the number in half — possibly without cutting back on the soldiers themselves.  That number speaks volumes about Pentagon waste.  For (b), we ought to figure out why the U.S. spends twice as much of it’s GDP on health care as its peer nations, yet gets no better results.  That number speaks volumes about medical waste, and examples are legion of pointless paperwork, frauds against the bureaucracy, and “treatments” whose cost-benefit equation is negative.  No doubt the health care costs could also be cut in half.  And for (c), we probably don’t need to raise marginal tax rates, we just need to streamline the tax and legal codes (to simplify financial decision-making, another huge source of wasteful economic friction) and make sure everyone pays fairly again.

None of this is easy, particularly because those profiting from the current culture of Federal waste will fight it tooth and nail, but together these actions could turn the U.S. current 10%-of-GDP deficit into a healthy surplus.  And they would free up a large fraction of the workforce to perform work that actually adds value to the country… not just adding statistics to “GDP”.

Cleaning Up: Thoughts on Muni Bond Market

Friday, December 10th, 2010

Thoughts on this:

http://seekingalpha.com/article/241172-stay-away-from-muni-bonds

Thanks for the fearmongering, but I don’t think it’s quite so bad.

Four points:

(1) The pension problem has been festering for a long time, and I just don’t see a kill-the-market catalyst or crisis other than the banking system having another liquidity crisis (like 2008).  But Bernanke has made it clear liquidity will be unlimited (for at least the next 3 years, eh) and the banks still own Congress behind-the-scenes and will not vote their own suicides. So unlike 2008, the market is unlikely to crash this time.

(2) The ongoing budget problems can and will (eventually) be met with rational cuts to “fluff” services, plus tax increases on those willing to put up with them.  Not to mention the monetary inflation that Bernanke is pumping into the system on a weekly basis!

(3) The ongoing, happening-right-now solution to the pension underfunding issue — once people wake up to the problem — has been (1) stop the bleeding – cease enrolling new employees in the troubled pension system and (2) make the workers pay for the pension – force current members of the plan to contribute to the pension out of salary (e.g. “your 2% COLA raise is now your pension contribution”).  This wave hasn’t reached all shores yet, but it’s visible — even in California (e.g. the University retirement system).  And retiree medical is just gone, at least until this nation gets serious about having a first-world medical system.  The public unions are still kicking, but the writing is on the wall… even in California.

(4) You claimed “My best guess is that two states go down — Illinois and California…” and then “If you have to own munis, own the better-quality states – in fact, own bonds that have first claim on revenues rather than general obligation debt.”  But you neglected to mention that in many states, including California, debt service payments are protected in the state’s Constitution.  Therefore a CA general-obligation bond is in fact quite like a revenue bond, protected by the tax revenues of the entire state.  That doesn’t make them risk-free, but they could well be lower-risk bonds than those issued (at currently lower rates!) by states which currently appear “better-quality” (short-term)!  Because those other states may have a more vulnerable (less diversified) economic base and lack the constitutional default protection…

In short, it might be quite profitable to do your own due diligence here, and wait for these fearful guys to bid up your preferred market after the crisis passes.

Comments on “Scary New Wage Data”

Monday, October 25th, 2010

Over at tax.com, David Cay Johnson follows up on a Social Security Administration report with some “Scary New Wage Data“:

“Every 34th wage earner in America in 2008 went all of 2009 without earning a single dollar … Total wages, median wages, and average wages all declined, but at the very top, salaries grew more than fivefold.”

“Not a single news organization reported this data when it was released October 15, searches of Google and the Nexis databases show. Nor did any blog, so the citizen journalists and professional economists did no better than the newsroom pros in reporting this basic information about our economy.”

Ouch.

Corroborating this Scary New Wage Data is the chart on Page 21 of the National Economic Trends report put out monthly by the St. Louis Fed (a small PDF: http://research.stlouisfed.org/publications/net/page21.pdf )

Proprietors’ Income and employee “Compensation”, as a share of GDP, have been in decline. Only corporate profits have increased as a share of GDP. The latter have returned to pre-crash historically high “bubble” levels. Compensation is approaching series lows last set in 2006. Proprietors’ Income is declining from a peak in 2004-2005, which may reflect the heyday of many small housing bubble businesses. But it is still above historical norms.

I share David Cay Johnson’s (that is, the original author’s) concern that this information received minimal media coverage. But I suppose that one cannot expect corporate media, funded by corporate advertisers, to publish news which would suggest that actions should be taken to rebuild wages and proprietor’s income at the expense of corporate profits?

It would also appear that the Obama administration has been a great friend to business, given that corporate profits as a share of GDP have increased nearly 4% since he took office.

Mean reversion of corporate profits/GDP to historical norms is to be expected, and implies a 30-50% reduction in the ratio (with magnified impact on equity prices since P/E ratios will contract as well) … but by what mechanism?

Do NOT Feed The Squid!

Friday, October 15th, 2010

I’d like to welcome my readers (all 2 of them?) from my other blog, Do Not Feed The Squid!  “DNFTS” was a great idea (and still is, so I’ve put it in the tagline above!) but I do not have time to keep up two blogs.  Also, the idea behind “Do NOT Feed The Squid”, that we’re going to have to take personal actions to stop the large financial corporations from continuing to abuse the legal system and destroy the public trust, is no longer as politically radical as it used to be.  It’s no longer a distraction from the “Ethical Investing” and “Sustainable Gains” themes here.  In fact, it’s pretty clear that investors in the mortgage lending apparatus have failed to invest ethically and are discovering that their fraudulent gains are not sustainable.  (Whether they continue to succeed in ripping off the taxpayers, only time will tell… but hopefully the public will not put up with this any longer!)

The 6 posts from “Do NOT Feed the Squid” have been moved over here verbatim, without any updates to their timestamps.

For those who may not have reviewed the “Do NOT Feed The Squid” site, here’s a list of the 6 posts in, reverse chronological order:

Post-Squid Investing Attitude Shift

Squid-Free Investing (small victories)

Preventing the Next Crisis? Automatic Stabilizers?

Restoring the Federal “Reserve”

A Quick Guide to Squid-Free Banking

What is the Squid?

More Mouths to Feed, Fewer Workers

Friday, October 8th, 2010

A recent post by Calculated Risk reminded me to comment that the Federal Reserve’s “EMRATIO” metric is worse than it looks (and it looks bad already).  EMRATIO is frequently misreported as being “the employment to population ratio”. Sometimes the writer aims to be less inaccurate and says it’s the “fraction of adults who are employed”.  EMRATIO is really meant to measure how much of the potential labor force is currently working, and typically runs around 0.6, meaning 60% of the “adult population” is “employed”. EMRATIO has recently been declining as a result of job losses during the recession, which is bad enough.  But there is a demographic issue in play as well, because of the aging population, and EMRATIO doesn’t capture this very well.  In EMRATIO, the “population” not only excludes children, it also excludes “institutionalized” adults (who still need to be fed … and many of whom could be productive).  EMRATIO doesn’t include the military – it’s just “civilian” employment. And EMRATIO also appears to include working teens in the employment number, but not in the “adult population” number.  So EMRATIO is really an approximate “civilian employment to adult workforce ratio”.  Which is fine, but not if everyone thinks it’s the actual employed workforce divided by the total population… because that number is substantially lower!  The employed workforce has to feed not only the unemployed adults but also the children, the military and the “institutionalized” adults (including criminals and more).

So EMRATIO is useful, but misleading.  I think what really matters is the “Mouths To Feed Ratio”, that is the number of “mouths to be fed” divided by the “number of workers” – and there’s a way to generate that using the Federal Reserve’s FRED graphs database:
More Mouths to Feed

What this shows is that during the Baby Boom years of the 50’s and 60’s, when there were a lot of single-worker households and a lot of children, there were 2.6 to 2.8 people per worker.  From the early 60s until 2000 or so, that number trended down.  Each worker had fewer and fewer mouths to feed, as demographics became more and more favorable.  But that situation has reversed.  The 2003-2008 boom failed to bring in enough workers to bring the MTF ratio back down, and the Great Recession’s job losses, together with older workers retiring, have sent the MTF ratio back up to levels last seen in the early 1980s.

In fact, if we invert the MTF ratio, we can compare it directly to EMRATIO, and we see that the MTF ratio is about 13% lower than EMRATIO.  I am surprised that this ratio isn’t smaller still, since there should be enough children to take it down 20-25%.  But clearly less than half of the nation is currently employed:

“EMRATIO” and the Actual “Civilian Employment” to “Total Population” Ratio

Finally, the last plot below shows the two components of the MTF ratio (but beware the suppressed zero in the graph).  Both have trended upwards and basically doubled in the past 60 years, but in the last decade the population growth has outstripped the employment growth.

Total Population and Civilian Employment

If population growth continues to exceed employment growth, there will be ever more Mouths To Feed per worker.  This in turn puts pressure on workers to lower their savings rates and defer retirement, or to lower their personal standards of living in order to support household dependents. It also creates pressure on both workers and employers to pay more in taxes, to maintain benefits for an increasing number of non-workers, via Social Security, Medicare, education and so on.  This will be a major challenge for public policy, and it also has major implications on the sustainability of economic growth and the current high level of corporate profits relative to GDP.

Footnote:  My data is from the FRED site; I would appreciate clarifications if anyone who reads this has some good links.

TIPS maxing out?

Wednesday, September 22nd, 2010

I ran across a fine posting tonight at Illusion of Prosperity which raised a topic that has been puzzling me for some weeks.  Why are TIPS yields so low, can they go any lower, and are the “inflation expectations” implied in the TIPS-Treasuries spreads meaningful?  The implied inflation expectations have been trending down through 2010, into the 1-1.5% range and well outside the 2-3% zone that the market lived in from 2004-2008, and the Fed is clearly worried about this.

Mark pointed out that those worried about deflation will pick Treasuries since in that case TIPS have zero yield.  Those worried about serious inflation will invest in hard assets. So why are so many people buying TIPS?

I had two comments regarding the TIPS:

First, not everyone is absolutely convinced that deflation is imminent, nor is everyone convinced that inflation is imminent.  But many are convinced that we’re going to have one or the other, but are just not sure which, as that appears to be a political choice. For those people, TIPS until recently made a decent “safe either way” option, particularly for tax-protected accounts. [Note: at current yields I no longer think TIPS are a safe choice against inflation… we are currently letting our TIPS ladder run off and finding other uses for the money until TIPS yields recover. ]

Second, I think it’s a serious flaw in Fed policymaking to assume that the TIPS and Treasuries markets are efficient enough to produce a meaningful “inflation expectations” measure through the relative yields.  One of the great lessons of the 2008 crash is that modern portfolio theory and the efficient markets hypothesis are both deeply flawed. I suspect it would be very interesting to plot the “TIPS/Treasuries Inflation Expectations” chart against actual 5, 7- and 10-year CPI growth, and see how accurate the metric has(n’t) been!  For instance, in 2003 the implied 5/7/10 year inflation expectation was about 1.5%/year, and the actual 5/7 year inflation was 2.5-3.0%. Similarly, in 2008 the implied inflation swung from 2.5% to -1% within a few months, and of course most of that range will prove in a few years to have been grossly wrong.

For my part, I find the TIPS yield alone to be very provocative. Bonds historically are expected to return 2-3% above inflation.  So the current 10-, 20- and 30-year TIPS yields of 0.7-1.5% could be taken, in and of themselves, to imply a negative inflation rate.  Alternatively, the 0% yield on the 5-year (and the other anomalously low yields) could be seen as implying that other asset classes look so overpriced (or corrupt and unappealing?) as to make even a 5 year zero real return rate look attractive!

Or maybe it just means that Treasury needs to issue more TIPS relative to Treasuries, to bring supply back in line with demand!  In that mindset, one can take the “implied inflation expectations” with a grain of salt, since Treasury controls the relative supply and can therefore radically influence the yield spread!  The U.S. recently tripled the annual issuance of Treasuries…  and the Fed is in QE mode… so what else would one expect but low real TIPS yields?  The real mystery may not be why are TIPS yields so low, but why are Treasury yields so low?  Higher Treasury yields are vital to increasing the “inflation expectations” implied in the Treasuries-TIPS spread… yet the Fed is actively buying Treasuries as it rolls over its (illegal) MBS holdings, and presumably (if it goes into the QE mode promised in this week’s FOMC statement) will buy even more!

A tangled web, indeed…

KMP = Kinder Morgan Ponzi?

Wednesday, September 22nd, 2010

A few months ago, Kinder Morgan Energy partners came up on a stock screen of mine.  The stock has been performing well and the company is in a vital economic sector, so I was attracted to it.  But when I was reviewing the financials, I couldn’t help wondering about the apparent fact that the dividend payout currently exceeds the earnings cash flow.  KMP has been bulking up its capital and using some of the proceeds to maintain its dividend.  This smells Ponzi to me!  And given the forward economic climate, this also smells very risky.

When it was just KMP making me nervous, I didn’t feel like posting it, but I’ve seen a few other stocks looking the same way recently — particularly a couple of dividend-yield stocks in the telecom sector — and now I’m wondering just how deep the rot goes.

I know from a separate screen that there are very, very few U.S. companies with excellent financial ratings and low debt-to-earnings ratios. And the ones that I saw generally didn’t have exciting future prospects.

I haven’t seen the “deleveraging” that we were promised, and which I believe is vital to getting the next long bull run of economic growth rolling, so I expect a lot more stock-price volatility within the next couple of years.

Real Capitalists Respect Regulation

Monday, September 20th, 2010

Regulation is vital to functioning markets.

Without regulation, there is no trust. Without trust, there is much more friction in the exchange of goods, development of brands, and so on.

Would you be comfortable buying food if the FDA were not regulating the agribusinesses to ensure (reasonable) food safety?  (Or would you prefer to live in China and worry about whether your children were drinking real milk, or a poisonous but cheaper substitute formulation?)

Would you be comfortable taking out a mortgage (or credit card) if the banks weren’t being regulated?  Or would you rather have to read all the legal fine print to ensure there was no hidden scam?  (Oops, we practically have to do that anyway…)

Would you be willing to send your children to schools with no public oversight?  To buy them toys if there were no safety regulations?

Of course not.

Which is why real capitalists respect regulation.  Because trust is vital to business and, in the absence of trust, we’d have much smaller markets – and much more friction in them – which would all crush business profitability.

Perhaps, then, instead of blindly deriding markets and regulation, we should be appraising them and understanding the economic value that could be destroyed if we do not take good care of our system?