What the market knew

For weeks we have been witnessing “footprints of policy change” in the prices of agriculture stocks.  While the S&P is down about 7% since the beginning of May, the agriculture ETF (MOO) is down 13% and Deere (DE) is down nearly 20%.  Our investment process is built on the fact that policy affects asset prices. Today’s 73-27 Senate vote to end the 45-cent break refiners receive for each gallon of ethanol they blend with gasoline and to scrap a 54-cent tariff on imported ethanol confirms what the market knew for weeks.

40% of the corn crop is converted to ethanol.  Without these subsidies, which directly cost $6 billion per year and indirectly cost much more due to the tariff on imported ethanol, far fewer rows of corn will be needed.  Some of the effects of this policy change will be – lower profits at gasoline refiners, lower demand for fertilizer, herbicide, and farm equipment, lower prices for corn and corn substitutes like wheat, rye and soybeans, lower food prices, and lower farmland prices.

The Obama administration’s and Fed’s persistent weak dollar policy somewhat offsets these forces.  Today’s vote clearly does not mean an end to U.S. food price inflation, but it does put it on a lower trajectory.  We believe that Ag stocks will not be good investments.  We are also now alert for cuts in subsidies and tax expenditures for other industries.  While such reductions are clearly good economic policy, they negatively affect asset prices in the targeted industry.  It is always good to end the government distortion of economic products and asset prices.  However when policies change, portfolios must be dynamically reallocated.

Paul Ryan Responds to President’s Disappointing, Partisan Speech | U.S. Congressman Paul Ryan

WASHINGTON – House Budget Committee Chairman Paul D. Ryan made the following statement after listening to the President’s speech on deficit reduction:

“When the President reached out to ask us to attend his speech, we were expecting an olive branch. Instead, his speech was excessively partisan, dramatically inaccurate, and hopelessly inadequate to address our fiscal crisis. What we heard today was not fiscal leadership from our commander-in-chief; we heard a political broadside from our campaigner-in-chief.

“Last year, in the absence of a serious budget, the President created a Fiscal Commission. He then ignored its recommendations and omitted any of its major proposals from his budget, and now he wants to delegate leadership to yet another commission to solve a problem he refuses to confront.

“We need leadership, not a doubling down on the politics of the past.  By failing to seriously confront the most predictable economic crisis in our history, this President’s policies are committing our children to a diminished future. We are looking for bipartisan solutions, not partisan rhetoric. When the President is ready to get serious about confronting this challenge, we’ll be here.”

 

Obama remains fixed on class warfare

Obama’s speech today, while great in terms of presentation, lacked substance and new actions.  He continues to be focused on class warfare.  He is a philanthropist and strives to do the “right” thing by leveling the playing field. He is using the debt and deficit issue as a smokescreen to get his class warfare tax hikes on the rich. He fails to point out that the money raised from such tax hikes on the rich will not be nearly enough to solve the debt crisis.  I do not think the electorate will be fooled into giving Obama his class warfare victory. Their actions in the past elections on the heels of the tea party movement proved that.  In 2012 I think the electorate will further strip Obama of power. I am not sure if that will show up in electing a new president or a new senate. But I think we will get one of those outcomes that further strips Obama of his power. His results so far surely prove he does not deserve more of it.

Thoughts on Obama’s speech today

I think given Obama’s speech today, we can’t take the Presidency.  I think, however, focusing on the House and Senate is do-able.  As I wrote, I think there is a generational change happening but it won’t happen fast enough to take Obama out.  However, taking Congress may be enough.  Spending has increased year after year since the Boomers dominated the Congress.  With the younger Tea Party members joining, we are beginning to see the Gen-X style at work.  Remember they lived through poor economic conditions when the future of the U.S. was up for debate.  (They saw gas lines and experienced double-digit inflation.) They value security. (Remember this happened while they were children when security and emotional memory are at their strongest.)  They aren’t the do-gooder idealists that the Boomers are.  They are trying to build wealth at a time when Obama wants to increase taxes to maintain entitlements for a generation (the Boomers) which they despise. (One only visit a bookstore to see how many books are written to mend the generational problems between Boomers and X-ers.) Paul Ryan, an X-er, best exemplifies their values.  They also experienced the power of lower tax rates as 100 million new jobs were added to the U.S. In these past 30 years (stat from Jim O’Neill, Head of Global Economic Research at Goldman-Sachs who considers this job growth the single most important contributor to our recent prosperity.). Unfortunately, the Boomer Congress has been spending faster than we have been growing under Democratic and Republican Presidents. Let’s focus on taking Congress and slowing the spending.

HT: Natalia Redenbaugh, my GenX wife and student of demography

The Fed is just plain wrong

Australia’s central bank stands head and shoulders above the rest.  They started hiking rates back in October 2009 and their current rate is far higher than in any other developed economy.  This means their savers get a much higher income on their savings.  Ah, but what about inflation?  The single best indicator I have found in my 40 year career is gold.  The Aussie dollar in terms of gold is worth roughly as much today as it was two years ago.  Meanwhile, the US dollar in terms of gold is down 60% from two years ago.  This US dollar inflation has not yet hit the general price level (CPI), but the gold signal cannot be ignored.  The Fed is just plain wrong and we are all paying the price.  Our good friend Scott Grannis posts some must see charts and analysis on the Fed’ mistakes.

The dollar is as weak as it is because the Fed is perceived to be the central bank that has eased the most and the central bank that will be the last to tighten; the Fed is falling behind the inflation curve. By over-supplying dollars to the world, the Fed has contributed significantly to weaken the US dollar, impoverishing us all and threatening to deliver years of uncomfortably high inflation. Will someone please forward these charts to Chairman Bernanke?

via Calafia Beach Pundit.

PIMCO Investment Outlook is a must read

Bill Gross does a masterful job at detailing our government’s unfunded liabilities.  It is important that investors understand the size and impact of these numbers. Politicians never speak of government off-balance sheet liabilities (Social Security, Medicare ad Medicaid) in terms that make it clear to voters the enormity of the problem.  All they talk about is cutting  discretionary spending.  As Gross points out this is a small piece of the total liability pie. And even so, the Congress is battling each other around $20 billion here and there in discretionary cuts. They argue in billions; the problem is in trillions.  Our portfolios have not owned US Treasury bonds in three years and we do not foresee a policy shift that would make them attractive again coming soon.

The above four multi-trillion-dollar liability balls are staggering in their implications. Remember first of all that the nearly $65 trillion of entitlement liabilities shown above are not some estimate of future spending. They are the discounted net present value of current spending should it continue at the projected demographic rate (importantly – it is much higher than the annual CPI + 1% used as a discounter because demand for healthcare rises much faster than inflation.) And while some Honorable Congressional Le Pews would counter that Medicaid is appropriated annually and therefore requires no discounted reserve, those words would surely count as “sweet nothings,” believable only to those whom they romance every several years at the polls. The incredible reality is that the $9.1 trillion federal debt that constitutes the next-to-tiniest ball in our chart is nothing compared to unfunded Medicaid and Medicare. It is like comparing Pluto to Saturn and Jupiter. The former (the $9.1 trillion current Treasury debt) does not even merit planetary status in our solar system of discounted future liabilities. It’s really just a large asteroid.

via PIMCO | Investment Outlook – Skunked.

Europe’s Failing Health

When you view these facts alongside the demographic facts, both Europe and Japan go broke.  They have far too many old people and will run out of young workers.  It is interesting that at a time when the EU is confronting the failure of their national health system, the United States is trying to copy that which cannot work when an elderly population is growing.

Traditional sources of funding health care in Europe have been branded obsolete and unaffordable. The need for innovation has never been stronger and while some countries, such as the Netherlands and Switzerland, are embracing change, others are resisting any significant overhaul. Indeed, the notion of free, state-backed health care is ingrained in the psyche of most Europeans.

Reformers want to reduce the state’s role in health-care delivery and introduce a competitive element. Those against change are adamant that a health-care system without state involvement is health care without a heart. Good for the rich, calamitous for the poor. It is an issue heavily clouded by emotion. But many feel that without innovation, crumbling state-backed systems will collapse as they struggle to cope with aging populations, soaring overheads and, more recently, mounting budget deficits.

via Europe’s Failing Health – WSJ.com.

Peggy Noonan: Why It’s Time for the Tea Party – WSJ.com

The left and the right establishment have dismissed the Tea Party as angry, white, racist, male, uneducated, etc. in an effort to make their votes seem less valuable.  Peggy Noonan does a masterful job of explaining the movement instead of looking down on it.

Are their politics a matter of principle over pragmatics?  That is, should one trade a safe but liberal GOP seat in Delaware for a long shot Tea Party Senator?  What effect will Christine O’Donnell’s victory in Delaware have on the rest of the country?  Peggy makes more than interesting points while gripping the reader in urgency. – Russell

So far, the tea party is not a wing of the GOP but a critique of it. This was demonstrated in spectacular fashion when GOP operatives dismissed tea party-backed Christine O’Donnell in Delaware. The Republican establishment is “the reason we even have the Tea Party movement,” shot back columnist and tea party enthusiast Andrea Tantaros in the New York Daily News. It was the Bush administration that “ran up deficits” and gave us “open borders” and “Medicare Part D and busted budgets.”

Everyone has an explanation for the tea party that is actually not an explanation but a description. They’re “angry.” They’re “antiestablishment,” “populist,” “anti-elite.” All to varying degrees true. But as a network television executive said this week, “They should be fed up. Our institutions have failed.”

via Peggy Noonan: Why It’s Time for the Tea Party – WSJ.com.

Reagan, Obama, Summers All Wrong on Tax Credit: Amity Shlaes – Bloomberg

Amity Shlaes is right.  This is a tip to big business and a tax cut for those who would have bought anyway.  At best this changes the timing, but it will encourage very little that would have not happened anyway.   Of course business will want these cuts.  I would too.  But one most consider the unseen costs of such policy beyond those who directly benefit.  Targeted tax policy favoring those who can make gifts is neither good ethics nor good economics.

Ineffective Policy – Besides being costly, this tax policy is ineffective, Goolsbee wrote. “The benefit of investment tax incentives does not go to investing firms but rather to capital suppliers through higher prices,” as well as to wage increases.It’s nice that equipment makers get orders, and it’s good that workers see higher wages than they otherwise might have. But if tax breaks are eaten up by price increases then the value of the tax break fades.

via Reagan, Obama, Summers All Wrong on Tax Credit: Amity Shlaes – Bloomberg.

taxes-what-people-forget-about-reagan: Personal Finance News from Yahoo! Finance

I agree with this assessment of Reagan.  However what is not said fully in the article is that very important changes were made in marginal real rates.  Total receipts increase when marginal rates are lowered and the tax base broadened by closing loopholes and shelters.  The entire theory of classical economics is to think and act at the margin.  It is important to look at the tax rate for the last dollar you earn, not the average rate you pay.  People make decisions at the margin.  If your next pay raise leaves you worse off, you will make different decisions about working, saving and investing.  This was the case before Reagan indexed the tax brackets.  Rates were very high, not on average, but on the margin because the curve was so steep.

Those who oppose higher taxes and are fed up with record levels of U.S. debt may pine for Ronald Reagan, the patron saint of lower taxes and smaller government.

But it’s worth considering just what Reagan did — and didn’t do — as lawmakers grapple with many of the same issues that their 1980s counterparts faced: a deep recession, high deficits and a rip-roaring political divide over taxes

via taxes-what-people-forget-about-reagan: Personal Finance News from Yahoo! Finance.

Will Democrats Extend ALL of the Bush Tax Cuts?

The incentives are to do this before the elections, not after.  There is less profit in doing it after November while in a lame duck session.  Watch this issue closely for something to happen in September. – Russell Redenbaugh

Supply-side economist Brian Wesbury now believes PDF that Democrats will extend ALL of the Bush tax cuts, even those for the “rich.”  Here are the three scenarios in which he sees this possibly playing out:Ideally, it would happen before the election this year. But this would require President Obama and the Democrats to turn dramatically, just when the public is paying more attention to politics. It would look opportunistic, it would demoralize some liberal voters and it would undermine the Democratic position that tax rates on the rich don’t matter that much to the economy.  How about in a lame duck session? If the consensus is right and Republicans take the House and make large gains in the Senate, it would give Democrats a chance to say they are listening to the voters. But in a lame duck session, Speaker Pelosi would still rule the House with little to no incentive to do the heavy-lifting needed to pass a bill. That leaves us with one more scenario for extending the tax cuts, the one loaded with the most taxpayer uncertainty, but which may be the most likely outcome. In this scenario, Congress fails to extend any of the tax cuts before the end of the year. All of the tax rates from 2000 – on everyone, from the “rich” on down – come back on January 1. Then, sometime in 2011, President Obama – his political advisers telling him to maximize growth going into his re-election battle – agrees to an extension but only through 2012, with all the lower tax rates made retroactive to January 1.

via Will Democrats Extend ALL of the Bush Tax Cuts?.

Peter Berkowitz: The Death of Conservatism Was Greatly Exaggerated – WSJ.com

History repeats itself.  Just as Nixon opened the door for Carter, Bush 2 opened the door for Obama.  Just as before, we will quickly tire of both and conservative ideas will bring us back to prosperity. The move back to freer markets and economic prosperity will happen much quicker this time as the world is more connected, allowing capital and ideas to move much faster.  I am not sure it will happen with this fall’s mid term elections, but it will happen.  I am positive Obama will be a one termer.   His only hope would be to move to the center and govern just as Clinton did.  However Obama’s “structure” prevents this.  He is too rigid, fundamentalist and righteous.  So instead we will get two more years of fighting and division as Washington splits politically.  Obama, the leader who was supposed to bring us together and change Washington, is driving us apart.  This will eventually open the door for real leadership with new pro growth ideas to emerge. – Russell Redenbaugh

Last August left little doubt that a conservative revival was underway. Constituents packed town-hall meetings across the country to confront Democratic House members and senators ill-prepared to explain why, in the teeth of a historic economic downturn and nearly 10% employment, President Obama and his party were pressing ahead with costly health-care legislation instead of reining in spending, cutting the deficit and spurring economic growth.

Still, whether that revival would have staying power was very much open to question. A year later—and notwithstanding the Democrats’ steadily declining poll numbers and the mounting electoral momentum that could well produce a Republican majority in the House and a substantial swing in the Senate—it still is

via Peter Berkowitz: The Death of Conservatism Was Greatly Exaggerated – WSJ.com.

Mohamed A. El-Erian – Why another fiscal stimulus won’t do

This is most thoughtful and discouraging. It points out the lack of political leadership now starting its second decade with no leader on the horizon. – Russell Redenbaugh

An already polarized political environment is becoming even more fractured by real and far less substantive issues. There is virtually no political center that can anchor consensus and enable sustained implementation of policy. Meanwhile, as anti-Washington sentiments rise, interest in a national agenda is increasingly giving way to the election cycle. Internationally, the impressive degree of cross-border coordination seen during the global financial crisis has been reduced to inconsistent — and at times contradictory — national responses.
This worrisome trio of increasingly ineffective national and global policy stances, intense political polarization and growing social pressures speaks to the risk that the economy’s recent soft patch will evolve into something even more troublesome and sinister.

I hope that sober policy responses will accompany the coming cooler temperatures. Given the proximity of the November elections, however, I worry they may not.

Mohamed A. El-Erian is chief executive and co-chief investment officer of the investment management firm Pimco and author of the 2008 book “When Markets Collide.”

via Mohamed A. El-Erian – Why another fiscal stimulus won’t do.

Calafia Beach Pundit: A bond bubble?

Great thinking by Scott Grannis on the bond bubble.  Another factor in the recent bond market surge is that there is a tax arbitrage out of dividend stocks an into bonds as a lower cost way to move pre-tax corporate profits to owners.  The dividend rate increase on the horizon  shifts asset prices substantially.

Looking back, the mortgage refi business also has roots in tax arbitrage.  It was a way to convert home owner’s equity into a stream of interest payments in a tax advantaged way often with AAA ratings for the lenders. – Russell Redenbaugh

We’re not witnessing a bond bubble in the making, we’re living in a statist nightmare. Bonds are not in a bubble, because they are priced rationally if you believe, as the market seems to, that the outlook for the future is grim.

The future, however, is not written in stone, and there is little reason—in my view—to expect that the current state of affairs is going to go on forever. But you have to be an optimist to venture outside the safe haven of ultra-low Treasury yields that only the pessimists are content to receive. Today’s bond market will prove to be a bubble if and when the people take back control of government from the statists currently occupying the White House and running Congress. I believe they will, come November. If you don’t, then go out and buy some of those Treasury bonds; you’ll have plenty of company.

via Calafia Beach Pundit: A bond bubble?.

Is California the Next GM?

The near bankrupt state of California is the front line for the liberal takeover of banks, car companies and all other things in the federal scope. Here is the real test. If the government can “nationalize” California then Washington’s agenda is greatly advanced. If the government is rebuffed it may turn the tide away from the assumption that Washington is the proper owner and controller for all activities that turn out worse than we wished for them.

California has created its own problems. The state’s money is more than gone, and the unemployment system is massively under funded. The normal solution is to renegotiate the retirement plan – the world’s most “generous.” However, political types have rigged it so these changes can only be made if the state is in bankruptcy or if the state constitution is changed. What great protection.

As our good friend John Hearne said, “Socialism ends when the government runs out of the other fellow’s money.” Well, California is there. They say tax the rich, but the California border states are already receiving a migration flood of wealthy people fleeing an oppressive CA tax code. Watch California closely. The result there will tell us how the nation will fare.

Jack Kemp

My friend, Jack Kemp, died last night. In the 30 years I knew Jack, he never spoke ill of anyone. He was an inspiration to me. He never saw my blindness as a limitation, and he always brought out the very best in me. I worked with him on the Kemp Commission, a task force to design pro prosperity tax policy. He was a national treasure, as he often said about others. I will miss him. – Russell Redenbaugh

A Stable Dollar

Changes in monetary policy from easy money to tight money cause banking panics. This often takes both lenders and borrowers by surprise and causes windfall gains/losses between them. It also causes changes in the general price level, switching from inflation to deflation.

A stable value of money eliminates these panics and sudden losses. However, with our money backed only by the promises of politicians we often fall into mistrust about the future value. This is what Art Laffer calls a loss of “moneyness.” We can fix this loss of trust or “moneyness” by tying the money to gold. This worked for thousands of years and was in a loose form until Nixon broke the standard in 1973, creating misery for the next decade. Let’s go back to a dollar we trust.

Forget Inflation Targets, Go for Dollar-Price Stability by John Tamny

Obama Can't Lead

Watching Obama’s press conference last week, I must agree with the CNBC host who said it was a “tentative news conference,” though I’ll add given by a tentative President. As the leader of the free world, we expect President Obama to command, order and declare the changes necessary to grow our economy and protect our country. Unfortunately, President Obama’s language reflected the weak role of a community organizer and not the powerful position of a President. When asked about his proposed budget which includes cap and trade, he responded that “in his opinion it is best,” and that he understood Congress would be reviewing it carefully. In short, he deferred to Congress. When asked about Mexico and the threat of drug cartels at our border, he informed us that expensive surveillance equipment and additional personnel were dispatched to “monitor” the situation which he assured us he “was taking seriously.” Of course, he needs to take this seriously. But we expect him to commit to action, assure us that he will stop the inflow of drugs and crime, not that he will be watching it. Another reporter commenting on the AIG bonuses opened with the claim “Cuomo is taking more action while you are merely expressing anger.” When speaking about the budget, Obama assured us that he is doing everything he can to reduce the budget but then reminded us it was difficult. This is like saying I’m trying but it’s hard. Another reporter said that he was alienating the Europeans by asking them to increase their stimulus. Obama was quick to say, “I haven¹t asked the Europeans to do anything! I’ve suggested.” Why isn’t he asking the Europeans to do anything? I would hope our President uses the authority we gave him to do more than suggest. Regarding the Middle East, a reporter reminded Obama that he pledged peace between Israel and the Palestinians. Ducking his commitment, Obama said that a two state solution is necessary and that we’ve “signaled this reality.” Signaled? This is not the vocabulary of a leader but rather a dreamer hoping things will go his way. Our President has the audacity to hope instead of lead!

by Natalia Redenbaugh

Deflation is Over

Per today’s Fed release, the monetary base increased 10% over the last two weeks and is up 104% yoy. M1 fell 1% on the week and is up 14% yoy. Excess base (monetary base – M1) is up 90% yoy. Looking further at the Fed’s balance sheet we see that reserve bank credit is over $2 trillion and is up over $1 trillion from a year ago. The increase in the monetary base over the last two weeks is due mainly to increases in Mortgage Backed Securities (up $168 billion) and Federal Agency Debt Securities (up $6 billion). These increases were part of the initial plan to purchase $500B in ABS. Notably, these purchases happened before the Fed announced new plans to purchase an additional $750B of ABS and $300B of Treasuries. The Fed’s combined plan will put roughly $1.55 trillion of ABS and Treasuries onto their balance sheet ($30 billion per week.) Expect Fed purchases to ramp and the monetary base to keep expanding. Deflation is over. It is time to continue adding to inflationary bets.

Global Warming Truths

There have been 54 distinct warming and cooling cycles since the Earth first cooled. 53 of these happened before human beings existed. So even if there currently is warming, about which the data are very unclear, then how do human CO2 emissions explain it? Think about this. Without the man made global warming story the government will lose all of that needed money, now estimated at $1.4 trillion. The government will also lose a chance to regulate the economy and trade. They lose a chance to make solar and wind power commercial as gas prices soar to $12/gallon. They lose a chance to favor certain group and industries by handing out carbon credits to favorites. Why would the government want to give up this enormous opportunity to grab power and expand itself? It is time to just say NO! No to bank bail outs and no to the bailouts of green energy businesses.

Sigh of Relief on Deflation

Today’s CPI release confirms yesterday’s PPI release – No Deflation. This is welcome news. Deflation is the big killer of asset prices. Just look at what happened when house prices deflated a little. The Fed was far too tight in 2007, increasing liquidity too little and too late. In fact, the monetary base didn’t start growing until more than a year after the Fed’s first rate cuts in 2007. Thus the downward spiral began. Throw in changes to mark to market accounting and the uptick rule and you suddenly have a toxic asset stew in a banking system collapsing from paper losses. Then when credit freezes in a “black out,” the real economy falls to its knees. The subsequent bail outs and stimulus only make things worse. Now after two painful years of deflation, it is coming to an end.

PPI Report Shows Welcome Reflation

Our banking system can deal with price level inflation. It can not deal with deflation and the crushing increase in debt burdens that result. Fed policies over the past year caused price level instability that was most disruptive to the banking system and the real economy.

The price of gold has been the best way to measure changes in price level over the past decade or so. It first fell in half, from $500 to $250, then rocketed up four fold to $1000. This “gold signal” directed buyers to move capital into housing as an inflation hedge. Housing’s appeal as a store of capital was of course augmented by the Clinton administration’s favorable changes in the housing tax code and their push to cause Fannie and Freddie to easily make mortgage loans to unworthy borrowers. When the Fed ultimately tightened, the bottom dropped out of the housing market.

Now the gold price is signaling firmer prices ahead for houses and other things. This is good news, as we can deal with inflation far better than deflation. Of course the best outcome would be a stable price level. This would create trust in the value of the U.S. dollar and zero inflation. However, our monetary masters want to fiddle with the money system. This tinkering gives the very savvy a chance to profit from the mistakes of the less well informed. Our only recourse has been to try to be among the best informed.

Housing Mess

Uncertainty over tax rates and regulatory policies cause companies to defer capital investments, bankers to stop lending and investors to stop buying. No one can know the value of a home mortgage. With changes in bankruptcy law, they can not even know their rights in foreclosure. The result is far less lending in this credit intensive sector. As demand decreases, house prices fall. Banks say they are pressured to make loans to borrowers that fail to meet credit standards, but wasn’t this the original cause of the problems?

Policy Errors Continue

Two policy errors persist. The first is mark to market accounting. The second is the rule adopted by the Bush administration SEC that allows short sellers to sell stock they don’t own without waiting for an up tick in the stock price. These two policy errors are working together to allow “gangs of short sellers’ to drive down the stock prices of banks. Thus, raising capital through stock sales becomes impossible. At the same time the paper losses from mark to market accounting drive banks into the arms of the government. These policies are wrong and must be ended.

Policy Matters, Now Profit From It

Here is a new article we wrote for www.realclearmarkets.com

March 05, 2009
Policy Matters, Now Profit From It
By Russell Redenbaugh & James Juliano
As a follow-up to our previous piece on absolute return, we will now show you one of the ways to make money when others are not. Investors must expand on our absolute return approach to investing and use changes in government policy to direct investment across multiple asset classes.

Understanding government policy is the best way we know to see and anticipate changes in asset values; not merely stocks, but also bonds, currencies, real estate, commodities and foreign markets. Changes in policy impact the economy by altering the supply/demand for products, labor and capital. This in turn changes the relative supply/demand for stocks and other asset classes.

Who's Surprised Markets are Falling?

We have outlined before how bad policies were becoming for taxes, trade and regulatory. And the hits just keep on coming. According to Bloomberg, “President Barack Obama’s administration will seek congressional approval for as much as $750 billion in new aid to bolster U.S. financial institutions if it is needed, ” and “AIG may get a commitment for as much as $30 billion in new government capital.”

Don’t be surprised markets are falling. Markets will not turn until policy turns positive. What’s more, could our national security be in jeoaprdy? What if we have a threat from a foreign enemy? Where is the will and the ability to respond? This could be a great chance for an oportunitic and adventuring enemy, and that is much scarier than falling markets. Obama, get it together.

How to Bottom Housing, Ingnite the Economy and Save the Banking System

There are plenty of ideas out there for how to stabilize house prices, reignite our economy and save our banking system. The Obama administration has outlined three separate plans to do so, totaling at least $1.5 trillion (stimulus bill =$787 billion, rumored second stimulus bill = unknown, housing bill = $287 billion and TARP 2 = at least 350 billion.) We think a better and singular solution for all of these problems is a simple price fixing scheme.

It all begins with housing. According to housing affordability data, house prices should have already bottomed. The National Association of Realtors’ data shows housing affordability at an all time high of 160 (meaning a family earning the median income has 160% of the amount needed to purchase a median priced home). Despite record affordability, house prices have not bottomed as they should have. Lack of confidence, selling pressure related to “margin calls” on underwater properties and banks’ frozen balance sheet have prevented a return to normal housing supply/demand economics. Our plan to fix housing begins with a spark to ignite the market and restore the proper supply and demand forces.

To bottom house prices we must affect the economics of housing supply and demand. We must decrease supply, increase demand, or both. Market forces have already done much to decrease housing supply, so let’s assume no policy is needed to keep new home construction down. So, how can we increase house demand and at the same ignite the economy? Simple. The plan is to offer a temporary tax holiday to any purchaser of an existing (not new construction) home. The amount of income that will be tax free should be scaled to the size of the home purchase (to keep it simple assume purchasing a $500,000 existing home would qualify you for a 6 month income tax holiday on $500,000 of income.) House prices would immediately bottom. Remember, we do not need to stop foreclosures. We need to stop house price declines. This will not help those people who never could afford nor deserve to afford their house payments. But for people on the edge, a 10% increase in house values will prevent them from having to foreclose. A 10% increase in house values would also save banks from having to write down more toxic mortgage paper and raise more capital. Lastly the income tax holiday would create a tremendous surge in work activity and ignite U.S. GDP almost instantly.

What is the cost of this plan? The cost of this plan is the amount forgone from lower income tax receipts. This would no doubt be less than TARP 2 and stimulus 2.

by James Juliano and Russell Redenbaugh

Attack on Capital

The Obama administration’s attack on capital continues. There is a bill proposed for a “Trader Tax” equal to .25% on every stock, option and bond transaction. Section 1 of the bill states that it be cited as the “Let Wall Street Pay for Wall Street’s Bailout Act of 2009.” They are trying to sneak a similar proposal for a transaction tax into upcoming health legislation. Up next will be energy and healthcare proposals designed to aid the recovery. They won’t. Since this administration is anti capital, the feedback loop of a falling stock market will not be seen as proof of bad policies. Inf fact, they view sell offs as fair and just.

Government is Lowering Your House Price

It has been clear for some time that the “just one thing” of the crisis is the collapse of housing prices. The banking system cannot be fixed until house prices stop falling. Now the government is lowering the price of your house by disrupting the contract between borrowers and lenders. Our good friend and great investor Chuck Kadlec explains,:

“Counter party risk in the U.S. is now being increased by the Federal government messing with contractual obligations of borrowers who pledge their house as collateral. Call it sovereign risk imposed on private markets. So, lenders and borrowers can no longer agree on what promise is being made, or assess what actions will be permissible if the promise is broken. Therefore, they cannot assess the sincerity or the capability of the promissory. The government, therefore, has created a new kind of uncertainty — adding to the barriers to commerce world wide, and decreasing the market value of the assets already on the books of the banks.” – Chuck

Mean Reversion – Longer Than Your Life?

Here is the link to an article we wrote today. It examines the perils of a relative return investment strategy and offers a different investment apporach for not only preservingcapital, but building it long term. It serves as an outline of the investment strategy we use at Kairos Capital Advisors to manage client portfolios.

Mean Reversion – Longer Than Your Life?

Protectionism Worries

Protectionism is a big worry, and the risk is increasing since the stimulus bill passed with “Buy American” provisions. Protectionism should be seen as a tax increase on all Americans.

China favors free trade, even if U.S. doesn’t
from Associated Press

Measures in a $789 billion U.S. stimulus package that favor American goods are a “poison” that will hurt efforts solve the financial crisis, an editorial by China’s official news agency said. Provisions in the U.S. stimulus bill approved Friday favoring American steel, iron and manufactured goods for government projects are protectionist measures that could trigger trade disputes, said the editorial….

U.S. labor groups that pushed hard for inclusion of the measures have argued that their main purpose is to ensure that U.S. Treasury dollars are used to the fullest extent to support domestic job creation.China has promised to avoid “Buy China” protectionist measures in its own multibillion-dollar stimulus effort, and appealed to other governments to support free trade….

President Barack Obama is expected to sign the economic stimulus package on Tuesday in Denver, Colorado

Stimulus Bill Passes

Our fears have been realized. The Senate did not block passage of the stimulus bill. Republican senators Specter, Snowe and Collins joined all the Democrat senators in voting yes. The stimulus bill will not stimlulate economic activity, and over the long term it will our economy much weaker. As a result we expect power in Congress to shift back to the right in two years and for Obama to be a one term President.

“The U.S. Senate late Friday night passed a $787 billion economic stimulus package by a vote of 60-38. The vote on the 1,071-page American Recovery and Reinvestment Act (H.R. 1) came hours after the U.S. House of Representatives approved the bill 246-183, with no Republicans supporting the bill. The bill is expected to be delivered to President Barack Obama’s desk for his signature by Monday. “

Art Laffer Conference Call Notes

This morning we were on the Laffer Associates conference call hosted by Art Laffer. Here are the notes from it:

Capitalized economic profits valaution chart shows that stocks are extremely undevalues. This gap will close and can do so in 4 ways. 1. Profits fall. 2. Interest rates rise. 3. Tax rates rise (after tax profits fall) 4. Stock prices rise. Laffer thinks gap will close due to first 3 reasons, not because stock prices rise.

1. Profits will fall as a % of GDP. Can fall by almost 50% from now levels to lowest levels, so lots of room for declinel. Also, GDP growth will be small, maybe negative.
2. 10 year yield is lowest in any time in recent history. Expect that to rise substantially. Monetary base signaling inflationary environment. Perfect storm for high inflation and rising rates – falling GDP and rising excess base.
3. Deficit projected to be over 8% GDP, not including all the new stimulus spending. Government will start worrying about raising revenues, and will raise taxes.

Grand policy areas (and ideal policy)

1. Fiscal – (fiscal restraint and low flat taxes)

2. Monetary – (Stable money, stable currency)

3. Trade – (minimal impediment to free flow of goods, services and people across boundaries.)

4. Incomes – (minimal regulations necessary to achieve order and structure in society)

What is happening in the policy domains:

Fiscal – there is no stimulus in the stimulus package. There is no Keynesian multiplier effect. For government purchases of goods and services there is a one quarter increase, then crowding out takes effect and there is n0 multiplier effect. Transfer payments actually reduce GDP.

Monetary – no linear relationship between any of the alphabet fed programs (TAF, etc) and bank reserves. And it is bank reserves that matter – monetary base. Until September 2008 the fed was too tight. This changed dramatically in September 2008 and the base has grown rapidly since. Fed assets gone from 904 billion to 1.9 trillion (2X). Total reserves 98 billion to 916 billion (10X). Monetary base 860 billion o 1.75 trillion (more than 2X). There is no sense from the Fed of taking these reserves out of the system. Largest increase of monetary base ever in US history. No sign the fed knows what it is doing or how to control it. Expect inflation and rates rise sharply. This is much worse than it was in the 1970’s.

Trade – In Davos the administration made it clear that they are putting in “Buy American” programs. In Britain there were riots over hiring foreign workers.

Incomes – green legislation, first presidential executive order was to strength unions.

Overall, very bearish on U.S. equities. Bullish on Gold and Real Estate (Laffer is buying Kentucky farm land for his grandchildren)

Geithner/Obama Failed Attempt

To steal a phrase from Jim Cramer, “He knows nothings!” Tim Geithner did not even release a plan today, merely a set of goals. No private monet will buy when the rate of return and terms are going to changing to help the borrower. Price discovery is not the problem. The problem is not being able to even guess at the cash flows. The current bank rescue plan will fail to save the banks. The current stimulus plan will fail to ignite the economy and will cause more long term harm that good. Ultimately, it is Obama who has failed. He is trying to create an administration that knows better than the markets and everyone else. The government is trying to be the allocator of capital, decding where it is most needed and best used. History has proven this never works and, after last night’s speech, it is clear Obama is a true believer in this approach. He will be a one term candidate.

Markets Vote on Obama/Geithner

Wall Street can oftern be wrong in the short term. However, over the long term stocks are titles to capital and reflect the present value of a company’s future cash flows. The government’s plans to “help” the economy and banking sector have been associated with declines in stock prices. The government aciton is making the future capital and cash flows less valauble. Shouldn’t this be a clue that they are not the right actions?

The following notes are from Davis Malpass of Encima Global:

Markets have reacted negatively to the Geithner plan, with equities falling and the three barometers of risk aversion all worsening – the yen strengthened, gold rose, and Treasury yields fell. This reflects several broad disappointments with the Obama Administration’s initial approach to the deep economic and financial crisis:

Treasury Secretary Tim Geithner’s 11am speech was unconvincing on the core issue of stopping the momentum-driven drain on bank capital. The plan probably won’t cause new capital to move into the banking industry or existing bank stocks to go up (a prerequisite for increased bank lending.)

There weren’t many specifics in Geithner’s speech, nor a sense of urgency. We like the expansion of the Fed’s TALF to $1 trillion and the idea of the public-private partnership of up to $1 trillion to buy assets, but Washington is moving too slowly.

Fed Data

The Fed released its H.3 (money stock measures) and H.6 (monetary base) reports tonight. For the week ending January 26th, M1 money supply was flat and is up 12.75% year over year. For the two weeks ending January 28th, the monetary base fell 2.4% and is up 107% yoy. Art Laffer’s measure of “Excess base”(monetary base minus M1) is now up 95% yoy. Back in mid November excess base was 70% yoy. and in the beginning of October it was 10% yoy.

So, the Fed continues to supply plenty of liquidity aimed at our financial crisis. In fact, markets are beginning to think it could end up being to much. The recent run up in gold and silver prices signal growing inflationary expectations. The Fed data explains these moves.

Mark to Market Accounting

There are comments from Washington suggesting that mark to market accounting rules may be suspended next week as part of the new bill. We pray this is true. Today’s rumor sparked the equity rally and an actual change in policy would go a long way towards extending it.

Government: Solution or Problem?

The following article is written by a seasoned political observer. He makes clear the conrete relationship between freedom and the prosperity of the country. He reminds us of another turning point, 1980, when we asked if government was the problem or the solution. In 08, the numberic inverse of 80, we asked for a larger and “more effective” government. His article is worth reflection about.

Economic Enemies of the State

Absolute vs. Relative

The relatively recent field of behavioral finance is most insightful and is gaining attention since winning a Nobel Prize in 1979. We are not economic maximizers. We are herd animals, not rationalizing machines. In part, poor behaviors come from our distant heritage and do not fit the calculations of “economic man.” The drive to belong pushes us to make relative comparisons. In investing, we do not want to be different and so measure our results against “the herd.” Clearly we want to invest better than the herd, but being different from it produces discomfort. For investors, this is the “relative measurement trap.” Even when we lose wealth, we seem to be “happy” if we lose less than the herd. This trap completely misses the point of what it means to invest and build long term wealth in an aboslute sense.

Deflation Hurting Russia

Deflation hurts our enemies much more that it hurts us.

Russian Debt Moves Toward “Junk” Rating

Stimulus Falters

We may be saved after all ,as the people are turning against the stimulus bill. The latest Rasmussen Reports poll “found that 37% favor the legislation, 43% are opposed, and 20% are not sure,” the first time a plurality of voters opposed the bill. Last week, support dropped like a rock among independents. This week Rasmussen reports that 64% of Democrats support the bill, but that’s down from 74% last week. Rasmussen also reported today that “Fifty percent (50%) of U.S. voters say the final economic recovery plan that emerges from Congress is at least somewhat likely to make things worse rather than better

Russia – What You Heard is Wrong

Russia may have cash, but the wealth of a nation is not in its cash or gold. A nation’s wealth is in its productive capability. With a collapsing currency, Russia’s economy must falter.

The Russian ruble dropped to new lows, threatening to test the level at which the central bank has pledged to defend it.

Tax Rates

Now we see why these guys don’t worry about high tax rates…they don’t apply to them.

Today’s Headlines:

Tom Daschle withdrew his nomination to be secretary of Health and Human Services. President Obama said Tuesday he accepted the withdrawal “with sadness and regret.” Mr. Daschle had failed to pay more than $100,000 in taxes in a timely fashion, and his relationship with EduCap is under investigation by the Internal Revenue Service.

Nancy Killefer, nominated by President Obama to be the federal government’s first chief performance officer, is withdrawing from the post, the White House said. An administration official confirmed that she is withdrawing over a tax problem. “On the heels of Geithner and Daschle, she just didn’t want to go through with it,” the official said.

Policy is Shaping the Markets

Tim Geithner’s protectionist talk towards China has the ability to spark a trade war. This policy blunder hangs over many sectors, especially emerging market investments.

Cap and trade, which recently was mentioned by the new administration as a possibility in 2009, hangs over energy investments. Not to mention ii has the potential to cripple our entire economy.

The administration’s social engineering agenda is most disturbing. They are pro labor and middle class while anti capital and prosperity. They really think the stock market is a bad thing and capital gains are just for the “rich.”

Overall, this violent lurch to the left is much larger and faster than we expected. It is now clear why a simple fix to this mess, a change in mark to market accounting rules, has not been implemented. Simple solutions are not embraced because they do not provide cover for other large agendas.

Is the Deflation Ending

Run to this piece by Scott Grannis. It is one of the best things we have read in a very long time.

Deflaiton Risk is Disappearing

Economics and Politics are Both Failing Us

Other than in a most general way, we really do not understand how international economics work. Our stimulus plan will increase the disequilibrium of global economies and disrupt markets. The stimulus bill is enormous in size. $1 trillion dollars is roughly the size of the entire Indian economy and about 1/3 the size of China’s or Germany’s GDP. It is a big, big number. For the government to spend that much it must borrow or tax it away from those who have it. If borrowed, that simply implies higher taxes in the future.

This financial crisis is a great blessing for those who seek a much larger role for government. They can expand their favorite projects and programs while increasing their influence over markets and outcomes. We would never want to do these things and know they will result negatively on our economy.

“Let’s Stimulate private Risk Taking” by ALBERTO ALESINA and LUIGI ZINGALES

Government can only spend what it takes away or borrows. This means that spending can increase consumption for those who receive the checks, but spending or investment must fall from those who pay the taxes or make the loans. Most data show that the multiplier on the borrow and tax side is higher than on the spending side. So even without the friction or government waste, the larger the stimulus package the larger the reduciton in economic growth will be. Of course, some transfers should be made for humanitarian reasons. We do not want people to starve or lack proper medical care, but this is charity not stimulus.

Gordon Brown’s VAT folly should be a sharp lesson to Barack Obama by John Tamny

Today's Fed actions are a HUGE deal

The Fed action today is a very big deal. The Fed finally got the message we have been preaching for a long time – interest rates don’t matter. The rates themselves do not measure easiness or tightness of monetary policy. There is no problem with interest rates close to zero. The Fed can expand the money reserves by purchasing other assets, and they are not limited to tbills or tbonds. They have been and will continue to buy other financial assets. Even buying gold or buildings would be transactions that add to the monetary base. The Fed now clearly understands that the imperative is to end the credit deflation, the asset price deflation and the “black out” of the credit system. All other problems come second, and no doubt there will be other problems. But for now the Fed has realized that deflation is a greater danger than inflation. To put it simply, deflation means game over. Today the Fed announced it will end deflation, and we may not get any inflation, at least not for a long while. The market risk is now political. The threats now are an increase in marginal tax rates or an increase in regulations, like cap and trade policy, that arrest economic activity. We are not out of the woods yet, but it certainly looks like we will have a brighter Christmas.

Gold's Important Signal

Interest rates will not tell us if the supply of money is easy or tight. The quantity of money will not tell us if the Fed is easy or tight. It is the intersection of both supply and demand that tells us. While the supply of money can be measured with precision (monetary base), the demand for money cannot be precisely measured. Price changes are the foot prints of changes in the the intersection of supply and demand. Gold is the best price change to watch for confirmation that the value of the dollar is increasing or decreasing. We are watching gold most carefully too see if the deflation will end or continue.

The Fallacious Notion of ‘Money Supply’
By John Tamny

Pensions lose billions

In investing, playing to beat the market causes managers and their clients to often do the wrong thing. Incentives matter, and how a manager is measured and paid will drive his behavior. Beating the market is a dangerous habit. It is a way to manage the client and the money manager’s business, but it may not be the best way to manage the money of real people.

Alpha Bets Turn Sour
Pennsylvania Pension Now Faces Billions in Losses
By RANDALL SMITH, Wall Street Journal

The stock-market downturn could force the Pennsylvania state employees’ pension fund to make cash payments of $2.5 billion or more to trading partners on Wall Street.

The potential hit to the $27 billion pension fund is the result of an exotic strategy used to help finance $9.2 billion in hedge-fund investments. Those bets helped the pension fund beat the market when stocks were rising, but backfired when the market sank.

Use of the aggressive strategy, called “portable alpha,” has been cut in half, with officials of the Pennsylvania State Employees Retirement System acknowledging that the pension fund’s exposure was “too large.”

Deflation Hurts

Deflation hurts our enemies more than our friends.

Following article from Stratfor.com:

Geopolitical Diary: Iran’s Bond Announcement and High Hopes For Talks

Iran’s deputy central bank governor, Hossein Qazavi, said Nov. 19 that Iran is considering issuing a $1 billion international bond “to attract international investment,” seven months after it repaid its last bond. The issuance would be Iran’s first since 2002, and only its third since the 1979 Islamic Revolution.

Through a bond market, countries look to “sell” their debts to international investors by parceling them into portions that can be bought individually. Raising money through the bond market is often easier than getting a loan from one or several banks; because the debt is divided into portions that investors of nearly any size can afford, banks and/or individuals with less capital on hand can come to the table. By getting more players involved, the country that needs its debt serviced can increase competition over the bond and thus decrease the price it has to pay for it. Of course, for this to work, someone actually has to want to buy the bond. Unlike a loan that is negotiated with one or several financial institutions, a bond market works on the principle of a market. It rewards credit-worthy countries whose debts are highly sought after (due to the state’s perceived financial strength and, therefore, its ability to repay the “loan” plus interest), and punishes countries that are not credit-worthy. In those terms, forays into the bond market are risky, as they potentially expose states to investor scrutiny.

The “stimulus package” can transfer jobs from one sector to another (say autos), bit it cannot create jobs.

The government can restore a banking system that is failing. However, if it pushes loans that lenders otherwise would not have made, then this simply adds to the problem of bad loans. This was the original source of the current probems (i.e. Community Reinvestment Act.)

If the government replaces private capital with public capital, it drives out more private capital. Government can “get out of the way’ or “get in the way,” but they cannot create prosperity.

“This is Obama’s Market, Good and Bad“ by john Tamny

Only in America

Be proud to be an American. Whether you are a Republican or a Democrat, Barack Hussein Obama¹s win makes history. Obama was not elected because he is African American, nor was he elected in spite of it. He was elected because many Americans have moved beyond seeing the world, and their lives, through the lens of race.

This moment in history is one that I though I would never see. Born in 1945 and raised in the 97% white state of Utah, my early experiences were in an environment in which racial prejudice was not a direct or first hand experience. My schools were all white, and they were not segregated. As a life long believer in Equal Rights, not racial preferences, this election was so clearly won based on the man, not his color. Obama is a man that every one can respect regardless of one’s political philosophy. His journey is truly a testament of all that is possible in our great nation. Raised by a single mother with a father who was not only absent, but living in a far away country, Obama’s climb to the Presidency is the definition of the American dream.

As a former U.S. Commissioner for Civil Rights under three Presidents, I celebrate the achievement of my country in electing an African American to our nation’s highest office. It is amazing to me that in my lifetime we¹ve gone from Jim Crow segregation to the election of Barack Obama as President. As an economist, I am one of many who worry about the economic costs of President Obama¹s policies. But also as an economist, I see that there is a substantial benefit to reducing the economic friction of race awareness, ending the “victim” mindset and increasing human potential.

Discrimination is not over, but Obama’s election diminishes the manipulative power of the race card. It takes away the excuses for why, “I can¹t.” It forces the youth of our nation to embrace opportunity instead of falling back on victim hood. Already in communities across my state of California, there is a palpable improvement in the mood between the races. Local leaders are beginning to hold youths who hang out on street corners to a higher standard. Something is already different.

Russell Redenbaugh
U.S. Commissioner on Civil Rights 1990-2005

More Unprecedented Monetary Policy Action

Last night’s Federal Reserve H.3 and H.4 reports show more unprecedented Fed policy response. The monetary base grew 8% from two weeks ago and is up 50% year over year. M1 grew 2% from last week and is up 8.7% year over year. This puts excess base, as defined by Art Laffer, at about 40%.

Reserve bank credit expanded another 182 billion from last week. Total reserve bank credit is now just over 2 trillion, up from 1 trillion last year.

WOW!

Obama to Form National Energy Council

Just in case you were wondering, this is a terrible idea. A council that is wiser than the markets?

Obama Should Form National Energy Council, Group Recommends

Nov. 6 (Bloomberg) — The Center for American Progress, a Democratic group led by a top official for President-elect Barack Obama’s transition team, is recommending that the new administration open an office in the White House to guide U.S. energy policy.

The report, which is to be released publicly Nov. 12 as part of a broad blueprint for the transition, will recommend that a National Energy Council oversee the work of agencies that have a hand in energy policy, including the energy, interior, state and agriculture departments, said Daniel Weiss, who works for the Center for American Progress Action Fund.

CAP’s president is John Podesta, co-chair of Obama’s transition team. The council would be patterned after the National Economic Council and the National Security Council, which have the president’s ear and coordinate federal policy in those areas. Weiss said he doesn’t know if Obama will adopt the idea.

“President-elect Obama has made it clear that a transition to a clean energy economy will be a central element of an economic recovery,” Weiss said. “It makes sense to have a coordinating council to ensure that agencies are working together toward that goal.”

Obama has said that he would like to generate 5 million clean energy jobs and cut down on global warming through the adoption of fuel-efficient cars, the use of renewable energy sources like solar and other efficiency measures.

Voters Got the Statism They Desired

Voters Got What They Wanted – More Socialism
By Russell Redenbaugh & James Juliano

Yesterday’s election was a vote for more socialism. It is what the majority of voters want, and it may even be what a majority of public companies want. But it is a bad idea.

We define socialism as the use of government and public resources to protect people from the consequences of their actions. Under this definition, we already have a great deal of socialism here in the United States. The current Bush administration’s financial bail outs, whether necessary or not, are just like the RTC in 1990 and are another example of the government socializing the losses in real estate, mortgage and financial markets.

Many large companies, especially those whose growth is behind them, prefer government to protect them from both change (especially in the form of new competition) and the consequences of their mistakes. There are numerous examples of these types of companies in the auto industry, insurance industry, banking industry and even in city and state governments.

The Dog that Did Bark

Has the market bottomed? Most risk spreads say, “Yes,” but the barking dog of Fannie and Freddie debt spreads says, “Definitely not.”

Investors are happily watching as credit markets improve. Since early October spreads across most markets have been contracting, signaling an end to the credit market “blackout.” The TED spread has fallen from over 4% to 2.65%. LIBOR has fallen from nearly 5% to 3%. Two through ten year swap spreads have collapsed, with the 10 year swap spread falling from 80 basis points to under 50.

However there is one loudly barking dog that no one, especially the government, seems to be paying attention to. That barking dog is GSE spreads.

The story was that these bonds were government guaranteed, but are they really? Recently, Federal Housing Finance Agency Director James Lockhart changed his language when describing the government backing of Fannie and Freddie from “explicit” to an “effective guarantee.” This roiled GSE debt markets a week ago, but these markets have been pricing in mistrust for much longer. Since the government took control of Fannie Mae and Freddie Mac on September 6th, the spreads on these two GSE’s versus treasuries have rocketed higher. For example the five year Fannie to government spread climbed from around 60 basis points to 150 basis points while the ten year Fannie to government spread widened from 50 basis points to 120 basis points. So what is this barking dog telling us?

We think it is a clear warning that the housing markets can not bottom until these spreads contract. Without mortgage money, there will be no housing bottom. If the only backing of GSE debt is the house prices, then these bonds should go to junk yields. If they go to junk yields, well then game over for housing. While James Lockhart’s unclear language made the markets jittery, even strong language about a guarantee would not have necessarily solved the problem. Language can not make the debt guaranteed; only government policy can. Until we see Congress address this issue with clarity and follow through with policy action, we remain skeptical that the government has any idea about how to save the housing markets. If and when they do the right thing to collapse these GSE spreads, we expect equity markets to celebrate with higher prices.

Rates Don't Matter

As we have written for years, interest rates don’t matter. And as Scott Grannis reminds us, it is the maount of money, not the rate itself.

Fed rate cut is likely, but that’s not what matters via Calafia Beach Pundit by Scott Grannis on 10/29/08

DISTRUST: How it toppled the investment banking industry

by Natalia Redenbaugh

Today’s blog is the result of a conversation I had with our housekeeper in which I tried to explain the failure of the investment banks in the simplest of terms. The widespread panic has trickled down in such a way that even our housekeeper is affected by it. Like many, she is gripped by panic and a lack of understanding. We thought my conversation might be helpful in clarifying what happened and in understanding how experienced, highly competent investors (handicapped by their own knowledge) failed to protect themselves and their clients. The cause was simply: Widespread, pervasive DISTRUST.

As a business anthropologist in the investment community (partner in Kairos) I am always watching people, particularly those networks of people that make up businesses and the market. To understand more about what happened in the market, I first explained how people act with trust or distrust. Have you ever had someone lie to you? Maybe not even lie but stretch the truth? Have you noticed how the distrust spreads? They may have stretched the truth about their competence in one area but knowing they exaggerated about one thing leads you to distrust them on unrelated issues. More obvious is when someone steals; say a housekeeper (not my housekeeper) pocketed a couple of dollars she found while doing laundry. You now begin to suspect that she has been stealing from you all along and this two-dollar incident leads you to believe she may have stolen hundreds of dollars. Perhaps you misplaced your earrings but you are now sure that the housekeeper must have stolen them.

It takes a long time to build trust. Unfortunately it can be destroyed in an instant. Now what if your housekeeper were to deny the incident, claim she never took the two dollars and you must have misplaced it? Distrust grows and there is no hope of rebuilding trust. The first step to rebuilding trust is to accept responsibility and offer to take action over time to rebuild trust. If you choose to salvage the relationship, you will give the person a chance to earn your trust back but it takes time and repeated, observable actions to win your trust back.

Mistrust

Financial market difficulties and the way the government has handled the problems have built mistrust. This mistrust started in the Clinton time with the “vast right wing conspiracy,” and really took off during Bush’s second term. Without trust there can be no loans, no investment, no commerce. Restoring trust must be the new president’s first and highest priority. – Natalia Redenbaugh

Ending the Blackout

The credit market blackout is finally ending. The recession may be mild. See Scott Grannis, who has been spot on following credit markets and calling a market bottom.

This is an excellent piece and a must read by Ken Fisher – Stocks to Survive On

As the old saying goes, “the stock can not act any better than the stock holder.” In the short run, everything is for sale at almost any price. For good companies with strong balance sheets and good managements, these are shockingly low prices for investors who have the ability to stay the course.

The Great Hedge Fund Unwind is Underway

Calling Bottoms

We are not in the business of calling market bottoms, but what would one look like. Today there were some very notable moves in asset classes other than equity markets , whose large swings and volitility are all over the news. TIPS traded in an 11% range today and now yield over 3% real. There was a huge move in REITS, with the broad REIT etf up 10% and Vornado up 15%. There was a break out move in the U.S. dollar today, up 2% to just under 83. Gold had huge intraday reversal selling off 10% to close at 850. High yield bonds traded in a 20% range high to low and closed down 7%.

Deflation fighting

Note that the concern has shifted from “headline inflation” to asset price deflation. The Fed at last has caught on, and on September 24th they started growing the monetary base. Last night’s Fed release show they grew it again this week. Monetary base grew 8% from last week and is up 20% YOY, up to $986B from $911B last week.

We have been warning about deflation (see “It’s Deflation Stupid“) and are happy the Fed finally got the memo. Also, it was John Rutledge over a year ago who was talking about the need for the Fed to stabilize asset prices not consumer prices in order to end the “blackout.”

Here is a good explanation of what is going on by one of the world’s best investors, Bill Gross. – PIMCO Investment Outlook October 2008

Mood of the Market

Given the volatility of the current market, we’ve returned to three distinctions we utilized in 2000 when managing wealth during the bursting of the internet bubble.

The distinctions are: 1) emotional reaction, 2) pervasive mood and 3) economic and company-specific fundamentals. We define an emotional reaction as a market over-reaction that can be either positive or negative. These reactions are usually fickle, short lived and based on looking at part rather than the whole economic or financial situation. Investors often assume that the current issue is critical, long-lasting and perhaps permanent. During the 2003-2007 bull market there were multiple opportunities to “buy the dips” as investors emotionally sold the bad news of the day. In each of these moments it paid to go against the herd.

The second distinction, a pervasive mood, is deep, widespread, long-lasting and mobilizes people to affect policy makers. A pervasive mood, positive or negative, generates a background assumption that often is the basis for taking the wrong actions. For example, the previous assumption that house prices will rise, combined with the regulatory incentives that made such an interpretation “guaranteed”, led to a widespread expectation by borrowers (and maybe everyone) that their real estate assets would increase faster than their payments would. The current assumption that all mortgages, whether in good standing or non-performing, are worthless has lead to a widespread discounting of assets that in the long run will prove to be more reliable and valuable than now assessed.

We have successfully used these distinctions of assessment and action to build and secure wealth. Specifically, when company and economic fundamentals are positive and the pervasive mood is either neutral or positive, negative emotional reactions provide excellent opportunities to bet against the crowd, or rather move against the herd, either buying or selling in a contrarian manner. This works very well when markets are basically rational but interrupted by intermittent irrationalities due to emotional reaction. It is this approach, or rather the wisdom and courage to act against the emotional pull, that separates an experienced investor from the novice or lucky one. Unfortunately it is not enough if the pervasive mood is out of synch with the economic/company fundamentals.

Currently, the market has become irrational due to a pervasive mood not merely an emotional reaction. This pervasive mood and the policies adopted in response to this mood are now impacting the real economy. By real economy, we mean not merely stocks and bonds but the ability of companies to make, buy and sell. This then feeds back to asset prices, business and consumer behaviors, reinforcing assessments and actions that support the pervasive mood and complimentary actions. This vicious circle of selling begetting more selling is where we are now. We are in a selling market, sustained by a mood and its related actions that remain unchecked as the circle feeds itself. This cascade will end at some point. Until it does, the way to preserve the scarce resource (capital) is to join the herd and to sell all the way down. In short, the market can stay irrational longer than many investors can stay solvent.

Over the course of 2008 we have raised cash substantially to near 50%. We hope this is the wrong trade and that markets will resume their uptrend. However, when facing a pervasive negative mood we think it is more important to preserve capital than risk picking the exact bottom. This strategy preserves our ability to act when the vicious circle turns to a virtuous circle. This will happen, suddenly and without notice, except to a few who are monitoring the interplay between these three distinctions. The goal is to preserve capital so that we can play when it is clear we can win the game and when the crowd is in an emotional response that will no longer affect the underlying economic and business financials. When the affects are already known, and the uncertainty diminished for those who are not ruled by their emotions, then the game tips into favor for experienced investors who understand the fundamentals.

The emotional reaction and the pervasive mood always over-react as we are experiencing now. The key is not to know how long a pervasive mood will last but be able to identify and move quickly when the shift occur before the herd follows. You don’t have to be the first to move on the shift but you can’t be the last.

Monetary Policy

Let’s try and reduce the confusion. Here is how we interpret the recent Fed actions based on H3 and H4 reports.

Monetary base, or high powered money, has expanded dramatically in the last two weeks, the first such correct move from the Fed since the crisis began around last August.
From our point of view the key is excess base growth, as Laffer defines it Monetary Base minus M1 (demand for money). We will eagerly watch the weekly fed releases for data confirming excess base expands at high rates; one week of data is not enough.
Total reserve bank credit (the balance sheet of the Fed) has roughly doubled but this is NOT a measure of change in system liquidity.
Total reserves have also doubled in the last two weeks and since last year but again this is NOT a measure of change in system liquidity.
The Fed has lowered the effective funds rate by about 75bp to about 1.25% by paying interest on member bank deposits held at the Fed.
Excess reserves have increase from $2billion to $68billion, these are reserves held by banks above the “required reserves.”

Our assessments are:

The Fed finally is adding liquidity. This may be too little, too late
The Fed must continue adding liquidity to keep excess base expanding.
It is very confusing and very hard to interpret Fed policy. This is increasing mistrust and risk aversion

Bad ideas for a slow economy

It is not a good idea to increase marginal tax rates in a slow economy. That is why it will not happen. It is also why cap and trade will not happen.

The Recession Debate Misses the Point
By John Tamny

Not Drilling is Foolish

There are two main arguments being made against U.S. drilling for oil. First, some claim that even if we wanted to drill, all of the oil rigs worldwide are booked and not available for many years. We ask the simple question, “If they are all booked, why are they all booked?” They are all booked because they are all drilling, and drilling leads to finding.

Second, some claim that starting to drill now would have no benefit since it will take 10 years or more to actually bring any oil to market. There are two things wrong with this view. First, new discoveries will begin to depress future prices immediately even if new supply is years in the future. Second, 10 years is not that long, and venture capitalists often invest with a horizon longer than 10 years. A little known facts is that anyone who invests in stocks actually invests with a time horizon much longer than 10 years. Our good friend and scholar, John Rutledge, writes, “Only 2% of the intrinsic value of the S&P industrials is based on profits earned within the first year…The first ten future years together account for only one-fourth of total value. And you would have to reach more than 30 years into the future to account for half of the market’s intrinsic value.”

If you think 10 years is too long, sell all of your stocks. We don’t think it is to long, and support drilling NOW.

Russell and Jim

Big or Small Government?

The election is a clear choice. Is the government the engine of growth or is the government then inhibitor of growth?

New Evidence on Fat vs. Slim Governments: The Early Supply-Siders Were Right
via CARPE DIEM by Mark J. Perry

McCain vs. Obama on Economics

Last night CNBC aired interviews with both McCain and Obama about their economic policies. We highly recommend everyone watch it. Here are some of our first impressions after the interviews:

- The election is a clear choice. Not since 1964 has there been a more distinct choice between different strategies for what should be a shared goal – prosperity. But the candidates have a very different goal in mind. One of shared hardship or prosperity. A choice between big government and even bigger government. A choice between what humans are: are we incapable of caring for ourselves? or are human beings capable, responsible selves who make mistakes and learn from them?

- Obama say the top 1% has captured all of the growth, not that they produced it, by implying that the top 1% took it from the other 99%. He clearly has no grasp of supply side effects.

- Obama wants to raise taxes on capital gains and dividends. 1/3rd of Americans (100 million people) are invested in the markets. So how does he plan to cut taxes for 95% of Americans while raising taxes on 1/3rd of them? Who is Obama’s chief arithmetic advisor?

- McCain is beginning to show up as having more character than Obama. There were even times during the interview when it seemed as if Obama was being outright deceitful.

The following article is a good example of a very simple economic principle – price up, quantity down.

“Is Min. Wage Behind the .50% Jobless Rate Jump? “ by Mark Perry

Flawed Energy Policy

It is hard to vote for higher energy prices. Of course, without higher energy prices cap and trade won’t work. It is a price increase scheme.

Following excerpt from Wall Street Journal titled “Cap and Burn”:
For months, Democrats and the environmental lobby promoted last week’s Senate global-warming debate as a political watershed. It was going to be the historic turning point in U.S. climate change policy. In the event, their bill collapsed in a little more than three days.

Democrats failed to secure a majority, much less the 60 Senators necessary, for a procedural vote on Friday morning that would have allowed the real work of amending the bill to begin. By that point, Majority Leader Harry Reid had already made it plain that he wanted the bill off the floor as quickly as possible – despite calling climate change “the most critical issue of our time.” But not critical enough, apparently, even to let his Members vote on the merits, much less amendments.

Historical Tax Hike

Tax rates do matter. They do change the level of economic activity. They do change behaviors.

2009 Budget Masks a Major Tax Hike, from Investors’ Business Daily.

Dollar Importance

Here is a good piece by Amity Shales titled, “Contracts as Good as Gold.” It reinforces our belief that the “just one thing” for investors and the economy is the dollar. Since their 2006 lows gold is up 50% in dollar terms and roughly 25-30% Euro and Yen terms. About half of the gold price run up is dollar weakness. Likewise, oil prices have tripled in dollars while doubling in Euros during the same time frame.

The dollar matters. And the change in the dollar is a product of many policies: tax, trade, regulatory, etc.

Europe's Demography Problem

This week French President Sarkozy laid out a proposal on immigration crackdowns as one of the key reforms that his country will be pushing when it takes the EU presidency in July for six months. His main focus will be on illegal Muslim immigrants. Importantly, Europe has an unsolvable demographic problem. Their birth rates are 50% below the replacement rate. (see our Death of Birth article) Social security and their retirement system will collapse soon as there are no new workers to fund retirees. This inter-generational chain letter has broken. Japan is an extreme case, but China has the same problem. Both Japan and Europe are “shutting down.” Both need to run trade balance surpluses to move capital off shore. – Russell

A strong dollar is an outcome of many other policies, not a policy itself. It is the “just one thing” for a good economy.

“Ben Bernanke Mentions the Dollar” by John Tamney, Realclearmarkets.com

High Oil Prices

The cure for high prices is…high prices. The “talk” of peak oil is an idea that recycles better than trash. It was popular in the late 70′s until the oil price fell 75%. The claim is “all the oil has been found.” I was always taught it is hard to prove a negative. What we do know and is easy to prove is that conservation and substitution effects work. Both will reduce demand. Maybe not in the short run, but it does happen. Hang on. – Russell

Following excerpt from Stratfor.com

Nymex crude oil closed at $122.06, down 1.8 percent for the day and down nearly 10 percent since the key commodity hit its record high two weeks ago.

The reason for the steep declines of the past few days could be one of a number of things. Possibilities include, but are not limited to, congressional discussion of limiting futures trading (leading to a surge of investor money out of the energy markets); sliding U.S. gasoline demand in the face of sustained high prices; normal seasonal shifts in consumption patterns; and statistical revisions that made oil traders think that supply shortages were not a likely development.

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The Geopolitics of $130 Oil

There is an excellent article by George Friedman on Stratfor.com (subscription site) titled “The Geopolitics of $130 Oil.” Our takeaway is that China is the loser in this game. They have the least room to maneuver and have less cohesion than most countries. Watch for serious economic and social problems in China if the “energy crisis” continues.

www.stratfor.com

The Dollar

The dollar is the “just one thing” for the economy, the markets and even the election. The candidate who pushes a strong dollar has my vote.

Hard Dollar by Larry Kudlow.

McCain's Energy Policy

Cap and trade is far more dangerous than a carbon tax. A tax allows both price and quantity to adjust. Cap and trade fixes the quantity and makes price changes very large and unpredictable.

McCain, the Cap-and-Trader by Larry Kudlow

No Respect for Hilary

GENERALLY I DON’T QUOTE THE VAST RIGHT WING CONSPIRACY, BUT HERE IT GOES ON THIS PIECE FROM THE NEW YORK TIMES AND BILLLY CRYSTAL.

FIRST, A LITTLE HISTORY…IN 1972 THE DEMOCRATIC PARTY EMBRACED THE ONE MAN ONE VOTE RULE. THIS WAS A LURCH TO THE LEFT IN REACTION TO NIXON’S VASTLY UNPOPULAR PRESIDENCY. THERE WAS AN UNPOPULAR WAR, A FAILING ECONOMY AND THE START OF WAGE AND PRICE CONTROLS. ALL OF THIS WAS TO GET MUCH WORSE SOON.

THIS POPULIST PARTY NOMINATED GEORGE MCGOVERN. HE WAS SEEN AS THE ONE WHO WOULD SAVE THE COUNTRY, SAVE THE ECONOMY, AND RESTORE THE MIDDLE CLASS. HE WOULD GIVE EVERY AMERICAN 1000 DOLLARS, AND THAT WAS REAL MONEY BACK THEN. BUT THE PARTY, THE MEDIA AND THE PROFESSIONALS WERE NOT LISTING TO THE COUNTRY. INSTEAD, THEY WERE LISTENING ONLY TO THEIR OWN SOCIALISTIC DREAMS OF A UTOPIA WITHOUT DIVISIONS OF RACE OR CLASS – A UTOPIA WHERE MARKET FORCES DIDN’T MATTER.

IRONICALLY IT WAS NIXON WHO IGNORED MARKET FORCES AND COLLAPSED BOTH THE DOLLAR AND THE WORLD ECONOMY. ISN’T GOOD TO FOOL MOTHER NATURE OR MARKET FORCES, WHICH ARE ONE AND THE SAME, BUT I DIGRESS.

IN THE ELECTION THAT FOLLOWED, SOCIALISM WAS REJECTED AS MCGOVERN CARRIED ONLY ONE STATE, MASSACHUSETTS. HE RECEIVED ONLY 17 ELECTORAL VOTES WHILE NIXON GOT ALL THE REST.

SO NOW WE HAVE IT AGAIN, A TEST BETWEEN MARKET FORCES AND IDEAL SOCIALISM. DEMOCRATS OFFER A DREAMY CALL FOR CHANGE AND HOPE. I MYSELF PREFER ACTIONS TO “HOPE”.

Russell

Hilary Gets No Respect, from New York Times

McGovern again?

Art Laffer taught us this. Without the truck, the truck driver has no job. And without the driver, the truck has no value. This is the double ellipse. What the Democrats do not know is that the American voter is well aware of these facts. This is why class warfare does not work in America. William Jennings Bryant proved it. More recently, John Edwards reproved it. In 1976 George McGoven proved it. He ran against a very unpopular president Nixon. He ran against a very unpopular war. His centerpeice was a $1,000 “Demogrant” to every family. The voters saw this could not work, and awarded him 17 electoral votes from MA and DC only. This is my hope for the 2008 election. – Russell

Clinton, Obama Put Middle Class On The Wrong Path To Prosperity By RAFAEL RESENDES AND JOHN TAMNY | Posted Thursday, March 06, 2008 4:20 PM PT.

"A" Bottom versus "THE" Bottom

We are reaching short term oversold readings on many market indicators. I think we are close to “A” bottom, but maybe not “THE” bottom.

The news flow (every headline about margin calls and the worsening credit crisis) as well as sentiment/psychology internals (put call ratios/insider buying, etc.) all point to short term fear and panic. The long term valuation story remains intact as well. According to a Laffer Associates model, the S&P 500 is almost 100% undervalued when compared to capitalized economic profits (NIPA). This all points to “A” bottom.

However for it to be “THE” bottom we need policy change.
– Fed must get fed funds rate down to short term Tbill rate
– Fed must produce enough liquidity to stop housing slide
– Treasury and White house should guarantee Fannie and Freddie

These actions can fix the financial markets. We will still uncertainty about November’s policy change hanging over the markets. The threat of anti growth policies from the next administration will keep markets in a trading range until we can assess what 2009 and beyond will look like policy-wise. However, if the Fed does the right thing now, that trading range prior to the election could have an upward bias. If the Fed fails to act soon, markets will trend even lower, deepening whatever flavor of recession we are currently in.

The big questions for investors who want to build long term wealth going forward are where to place bets once the future policy direction become clear. We are searching for opportunities. – Jim

Household Net Worth

David Malpass, Chief Economist at Bear Stearns, has a great take on the recent household wealth figures released by the government. We agree with him. The normal thinking is wrong. The household savings rate is high, not low. Household new worth, both with and without housing, is high and rising. Corporate profits are not falling. There is, as of now, no major sign of recession. Stocks trade like we are near a major bottom. Fear is very high. – Russell

Oil

Oil recently hit a new high. Markets were shaken on Monday as the inflation adjusted price of oil eclipsed the old 1980 high. This is somehow viewed in the press as a negative. We see it the opposite way. It took 28 years for oil to make a new high. That is an annual rate or return near 2% – a very poor investment.

Weak Markets

What has been causing the weak stock market and dollar? What is causing oil and gold to spike to new highs? It is not housing. It is political. It is the threat of a possible end to Hillary’s campaign. Not that she is any friend to prosperity, free trade or growth. But she is less hostile to saving, investment and free markets than Obama.

Greenspan or Bernanke?

Listening to Bernanke’s clarity while addressing Congress makes me long for the confusion of a Greenspan testimony. The bottom line is that we can understand Ben, and he is clueless. He does not understand that losses will pile up as long as house prices decline. He is surprised that rate cuts caused oil and commodity prices to spike to new highs. He is trapped in a Keynsian, Phillips curve model. He is unaware of what really causes inflation – too much money. He also seems unaware of how markets work.

Greenspan was not great. He was an average chairman who improved a lot when Wayne Angel served and guided him to use the gold price as a policy indicator. But Greenspan seems to be far better than Bernanke. At least Greenspan was able to confuse Congress in a way that sounded brilliant and like he knew what he was doing. Greenspan could produce trust. When Bernanke talks I feel lilke shorting the dollar.

Russell

More Election Thoughs

I am disturbed by this story even though I have been expecting it.

“Obama’sLead in Delegates Shifts Focus of Campaign By ADAM NEGAUNEE Hillary Rodham Clinton’s advisers made it clear that they were prepared to take a number of potentially incendiary steps to build up her delegate count.”

For the boomers, this would be seen as yet another betrayal. For the Gen X’ers who came out for Obama, this betrayal would mean they stay home in November and fall back into political resignation. – Russell

Election Thoughts

I predict that the election will come down to Obama versus McCain. Integrity is the theme of this election. Both Obama and McCain are well respected.

The more Hillary attacks Obama, the better chance he has to win. He challenges all the African American stereotypes which makes him appealing to white voters. Consider this: Obama is a young African American male without any dirt. If there was anything to find, Hillary would have found and exposed it already. He’s a squeaky clean, charismatic, hard-working candidate. His attendance record is impeccable.

McCain is a true patriot. As A POW, he is the only candidate qualified to speak about war. His “straight talk” campaign builds on the trust he’s already earned.

There are so many, especially in my generation, independents. These independents will entertain either of these candidates based on the issues.
This is the first time that my liberal, Vegan assistant and I are entertaining the same candidate: McCain. His integrity and experience appeal to us both.

This is not to say that McCain has my vote yet. With Obama quoting Reagan, I may consider him. As Art Laffer said, if Obama adopts Reagan’s economic policies “I’d vote for him.” Obama is a more positive, appealing young candidate who could easily get my vote if he goes “supplyside.” He’s an engaging beacon of hope. -Natalia Davis

Weak Dollar

A WEAK CURRENCY IS NOT GOOD FOR INCOME, OUTPUT AND EMPLOYMENT. THE ISSUE WITH ANY CURRENCY IS “TRUST.” THE DOLLAR IS A PROMISE OF OUR GOVERNMENT, THE PROMISE OF STABLE VALUE. THIS PROMISE WAS BROKEN IN A SHATTERING WAY IN 1971 WHEN NIXON TRICKED WORLD MARKETS AND ALL AMERICANS BY UNCOUPLING THE DOLLAR AND IT’S LINK TO GOLD. THE RESULTS WERE DISASTROUS AND PRODUCED THE ECONOMIC CONDITIONS THAT RESULTED IN AN ENTIRE GENERATION OF AMERICANS BELIEVING IN SCARCITY. FROM THE TIME GEN X WAS BORNE IN 1965 UNTIL THEY STARTED COLLEGE ABOUT 18 YEARS LATER THE DOW JONES WENT FROM 1000 TO 676. THIS IS BEFORE INFLATION. NO WONDER THE MOTTO FOR GEN X IS “IN US WE TRUST.” THIS MISTAKE NOW IS NOT NEARLY AS SERIOUS AS THE NIXON TRICK. BUT IT NEEDS CORRECTING. HOW CAN ANY OF US TRUST OUR GOVERNMENT IF WE CAN NOT TRUST THE CURRENCY. WATCH FOR A CHANGE IN DOLLAR POLICY FROM THIS ADMINISTRATION OR THE NEXT. THERE ARE VOTES IN PROMISING A STRONG DOLLAR AND THE TAX POLICIES THAT BRING THAT ABOUT.

Rangel Tax Reform

We can have prosperity and uneven outcomes. Or we can have “fairness” with far less prosperity. We can not have both. Low marginal tax rates cause the “rich” to pay a larger share of taxes paid. Which do we want? Distributive justice or procedural justice?

Inconvenient Tax Truths by Pete DuPont

Greenspan Book

THIS WAS AN EXTREMELY READABLE AND ENJOYABLE BOOK. MOSTLY BECAUSE IT WAS A REVIEW OF THE ECONOMIC AND STOCK MARKET HISTORY THAT I LIVED THROUGH AND LEARNED OVER THESE PAST 40 YEARS. I VERY MUCH AGREE WITH REVIEWERS CRITICISMS OF “THE CHAIRMAN” AS A CENTRAL BANKER. HE WAS, AND STILL REMAINS, TRAPPED IN THE PHILLIPS CURVE BELIEF THAT GROWTH CAUSES INFLATION. HE CONSTRAINed GROWTH IN THE MONETARY BASE FOR MANY YEARS BELIEVING THAT THE U.S. ECONOMY COULD NOT POSSIBLY GROW FASTER THAN 2%. THIS LEAD TO PERIODIC CREDIT CRISES AND DEFLATIONS. HE IS NOT GENEROUS IN SHARING CREDIT, AND RARELY EVEN MENTIONS ANY OF THE OTHER FED GOVERNORS BY NAME. SOME OF THE BEST POLICY WAS WHEN WAYNE ANGEL WAS ON THE BOARD AND THE FED DID PRICE LEVEL TARGETING. GREENSPAN BELIEVES IN THE MASTER CENTRAL BANKER, THE MAESTRO, THE SMARTEST OF THE SMART. I LEARNED FROM WAYNE ANGEL THAT THE FED SHOULD TARGET THE PRICE LEVEL, NOT STOCKS OR HOUSE PRICES.

Fed cuts

The following commentary, by Mike Farrell, CEO of Annaly Capital Management, explains why we can not know the future and why the Fed must keep cutting rates.

Seduced by a Super Model

Socialized Medicine

Socialized medicine, once intended to spread the risks, now seeks to spread the costs of risky behaviors.

Cherry Garcia and the End of Socialized Medicine by Peter Huber

The Age of Mass Innovation

In the past, again and again, we have come back from the brink. World War II. The 1970′s threat from Japanese business. 9/11. But please, could we plan ahead a little better? The rest of the world is cutting marginal tax rates and lowering regulation. We are trying to increase both. If we are not careful we could become the UK of the 20th century.

The Age of Mass Innovation from the Economist.com

Free Markets

I do not want to take sides on the “right” tax rate for carried interest. I do however call attention to the amazing results of the post 1980 U.S. economy and financial markets. I strongly support the idea of free markets. It is far better to let the market make these decisions about the “right” price, “right ” interest rate, and “right” rate of return. When the market produces outcomes that I do not like, even I am tempted to think that wise men should help make these decisions. The press would make one think that the U.S. economy is falling apart. Deficits in trade, current account, federal budget, and unemplyment rate are all terrible. Yet when compared to Europe we grow, work, save an invest. Income gaps do widen, but then they always do when growth happens. Rest assured, we are doing remarkably well.

Let the Good Times Roll by John L. Chapman

A Vital Engine of Economic Growth by John L. Chapman

No Top Yet

THERE IS TOO MUCH MONEY CHASING TO FEW STOCKS AND TOO MUCH STUFF. PLUS, THE SUPPLY OF STOCKS CAN INCREASE FASTER THAN THE SUPPLY OF STUFF. INTERESTINGLY, THE SUPPLY OF STOCKS DIMINSHED NOT INCREASED. NO TOP YET.

Blinded by the Derivatives Boom by Doug Kass

Why Republicans can win in 08

WELL, NOW I HAVE A BETTER UNDERSTANDING OF BERNARD LEWIS’ OPTIMISM ABOUT IRAQ. I ALSO SEE THAT THE DEMOCRATS ARE PLAYING A “LOSING HAND” AS THE INTERESTS OF IRAN AND THE U.S. COME INTO ALIGNMENT. THINGS MAY GO WELL IN IRAQ, LEAVING THE DEMOCRATS WITH NOTHING TO CAMPAIGN ON EXCEPT CLASS WARFARE. IF THINGS GO BADLY IN IRAQ, WE WILL PULL OUT AND THE DEMOCRATS AGAIN WILL HAVE NOTHING TO RUN ON BUT CLASS WARFARE. WILLIAM JENNINGS BRYAN PROVED YOU CANNOT GET ELECTED AS A POPULIST. EVEN HANDSOME JOHN CAN’T WIN THIS ONE. AT THE SAME TIME, ECONOMIC NEWS IS GETTING BETTER AND BETTER. THE FEDERAL BUDGET DEFICIT IS VANISHING INTO THIN AIR, SOON UNDER 1% OF GDP. THERE MAY BE NO NEED FOR A TAX HIKE. PERHAPS TAX CUTS? OR A FLATTER, FAIRER TAX? DROPPING THE INCOME TAX FOR MOST AMERICANS? DEMOCRATS HAVE NOTHING TO RUN ON, AND REMEMBER, GEORGE BUSH IS NOT RUNNING.

Following from Stratfor.com May 16, 2007 23 55 GMT

By George Friedman and Reva Bhalla

At long last, the United States and Iran announced May 13 that they will engage in direct public bilateral talks over Iraq. From Washington, it was the office of Vice President Dick Cheney and the National Security Council that broke the news. From Tehran, President Mahmoud Ahmadinejad confirmed that the two sides will meet in Baghdad in a few weeks, most likely at the ambassadorial level. That makes these talks as officially sanctioned as they can be.

Already there have been two brief public meetings — albeit on the sidelines of two international conferences — between senior officials from the Iranian Foreign Ministry and the U.S. State Department in March in Baghdad and in May in Sharm el-Sheikh, Egypt. The upcoming meeting in Baghdad, however, will be the first official bilateral meeting. After months of intense back-channel discussions, both sides have made a critical decision to bring their private negotiations into the public sphere, which means Tehran and Washington must have reached some consensus on the general framework of the negotiations on how to stabilize Iraq.

This may be why the markets are so strong. If the war goesbadly we will get out. If the war goes well we will get out. Then, what do the dems have to run on? Taxes?? – Never.

following by Larry Kudlow from Kudlow’s Money Politic$
Democrats Dooming Themselves to Defeat (My latest syndicated column.)

The Democratic Party may be convincing itself that it’s riding high in the polls toward a White House victory in next year’s election. But you know what? On two key themes — taxes and national security — the Democrats may be dooming themselves to defeat.

Watching the two presidential debates, one can’t help but notice the stark differences between each party’s approach to these core issues. And it’s hard to see how the general electorate is going to buy what the Democrats are selling.

To a person, each Democratic presidential candidate wants to undermine the global war against jihadist terrorism — wherever it may be, and especially in Iraq. The Democrats see a civil war in Iraq, where the Republicans view a growing al-Qaida threat. And while Republicans talk about significantly increasing the defense budget and expanding American force levels for all the armed services, the Democrats are hoping for some sort of Iraqi peace dividend upon immediate withdrawal — one that can be re-channeled into higher domestic social spending.