Muwabi Economic Forum

On the rare day I agree with anything Paul Krugman says, it’s actually worthy of a post. Today is one such day and will excerpt some of his article today…

America Is Not Yet Lost

Last week, after nine months, the Senate finally approved Martha Johnson to head the General Services Administration, which runs government buildings and purchases supplies. It’s an essentially nonpolitical position, and nobody questioned Ms. Johnson’s qualifications: she was approved by a vote of 94 to 2. But Senator Christopher Bond, Republican of Missouri, had put a “hold” on her appointment to pressure the government into approving a building project in Kansas City.

This dubious achievement may have inspired Senator Richard Shelby, Republican of Alabama. In any case, Mr. Shelby has now placed a hold on all outstanding Obama administration nominations — about 70 high-level government positions — until his state gets a tanker contract and a counterterrorism center.

What gives individual senators this kind of power? Much of the Senate’s business relies on unanimous consent: it’s difficult to get anything done unless everyone agrees on procedure. And a tradition has grown up under which senators, in return for not gumming up everything, get the right to block nominees they don’t like.

In the past, holds were used sparingly. That’s because, as a Congressional Research Service report on the practice says, the Senate used to be ruled by “traditions of comity, courtesy, reciprocity, and accommodation.” But that was then. Rules that used to be workable have become crippling now that one of the nation’s major political parties has descended into nihilism, seeing no harm — in fact, political dividends — in making the nation ungovernable.

How bad is it? It’s so bad that I miss Newt Gingrich.

Now I’m not going to defend the author here. Krugman is directly contradicting his stance on the same issue when Democrats were in the minority and desperately needed this power to prevent Republicans from doing anything in 2005. Krugman is a committed ideologue in both his economic and political views, which is a shame because he’s an extremely intelligent man in academia. The issue is not Krugman though, it’s the content of what he wrote. As I’ve said numerous times before, the filibuster is unconstitutional. What’s even worse is that I would liken the filibuster to a gun lying in the middle of the prison yard. You’re simply begging for the lawless, corrupt members of society to use and abuse it.

Think I’m exaggerating it? Yes, I most certainly am. However, we now see  Democrats pushing for filibuster reform. Obviously Republicans are adamantly opposed to these measures. Seem familiar? Let’s recall 2005 when Democrats were doing exactly the same…

Who opposes filibuster reform?

As of May 4, 2005, all of the 45 members of the Senate Democratic caucus were opposing the effort of Senate Majority Leader Bill Frist (R-Tn.) to abolish filibusters on judicial nominees

If more than five Republican senators vote with the Democrats, it will not be possible to establish the precedent that filibusters are not allowed on judicial nominations.

As of May 4, three Republican senators had come out clearly against the reform: Lincoln Chafee (RI), Olympia Snowe (Me.), and John McCain (Az.).

McCain, who some political observers expect to seek the Republican presidential nomination in 2008 as he did in 2000, announced in April that he will oppose the reform.

On the MSNBC program Hardball on April 11, host Chris Matthews asked McCain, “You’ll vote with the Democrats?” McCain replied, “Yes . . .”

I may disagree with the three Senators listed above but can at least respect their intentions are in the right place. Every other person who supported filibuster reform in 2005 and is now opposing it is not fit for public service. Likewise every person who opposed filibuster reform in 2005 and is now supporting it is not fit for public service. It’s really not surprising, however, as most of these people are so lost in partisanship they don’t even seem to realize how hypocritical they are. It’s nauseating to watch this behavior in action and a reflection of why we sit in such a dire state of affairs. People are so wrapped up in their own agenda or hatred of the other side, they don’t even consider common sense governance, constitutional principles, or what they said 5 years ago. It’s so sad that Krugman’s Polish analogy actually makes a lot of sense.

Rather than continue commenting on these senseless political stories, I will refrain going forward. I really think we’ve reached a point where the best way to deal with these situations is to avoid fighting the battles and focus instead on how to protect from its adverse consequences. Failure in governance led us to our economic predicament and failure in governance is making things worse in its aftermath. Rather than pointing out the obvious (because I could make a living doing it), it’s better to understand, educate, and react to what is going on. This website will be adopting this strategy going forward.

Tomorrow I will be adding a new feature to the website, a Muwabi actively managed portfolio. The intent is not to provide investment advice or publicly disclose my own holdings because this is not what I aim to accomplish. If I were doing either of these things, it would be much more closely researched and managed. I will put up a legal disclaimer on every portfolio report to make this very clear. The reason I’m adding this feature is to begin tracking how much of the commentary might look in an investment portfolio. When the average person reads about heavy economic indicators, it can be somewhat dull and meaningless to their own life. When you put it in the context of how this might impact certain markets, industries, companies, and asset classes there is an entirely different perspective. Again, I’m not advocating any specific trades or dispensing investment advice but simply demonstrating how one such portfolio might look and perform.

I will be updating my holdings as I see fit and disclosing performance results on a periodic basis. This will all be tracked on a separate blog format using a link to be created tomorrow. The URL for this will be www.muwabi.com/portfolio. Of course I’d like to see this portfolio perform well but it’s really more experimental than a grand attempt at making money.

The portfolio will start with $1 million and include a mixture of long and short positions, although much heavier weighting to the shorts. All securities will be bought and sold using macroeconomic analysis rather than a bottoms up, technical, or correlation type strategy. All results will be posted exclusive of commission, taxes, or fees. Finally, I will only be including stock and ETF transactions in this portfolio- no derivatives, REITs, bonds, or other alternative investments. I probably won’t comment much on the actual blog about this portfolio because it’s really more of an observational feature.

The following holdings will start the Muwabi portfolio:

Yesterday’s post started making the case for whether the key economic indicators are turning around. My hypothesis is that we’ve seen decent numbers in certain instances but all represented a seasonal or temporary trend rather than anything sustainable. For the most part, however, the key indicators like consumer credit, employment, and housing remain abysmal. The question is whether these facts are being reflected in capital markets and how my various forecasts will impact them. Let’s explore…

If the only economic news you’ve been tracking (and many people do) is the stock market, you might think we’re in the next boom of a lifetime. From the bottom in March to the top, the S&P 500 grew by a whopping 67%. This type of growth in less than a year’s time has only occurred during the Great Depression. Lately, however, there have been some hiccups in this run-up story…

As you can see from the graph, the latest dip has been the biggest since March and reflects a slowing trend in the overall appreciation. After price growth of this magnitude in the absence of any good news, a slow down was inevitable. The question from here is whether we see another big correction similar to 1931 or a square root shape. My bets are on the former.

First let’s explore why we saw such a quick and exaggerated growth pattern. Undoubtedly, we saw the stock market collapse far further than its true valuation and thus a quick correction back to more reasonable prices was easy to predict. To understand why this was so sudden requires brainstorming how our investment system works. Long only investment advisers typically got hammered in 2008. Retirement accounts were taken to the cleaners at the critical time before Boomers were set to retire. Pension funds were in crisis as their obligations were already underfunded. Big investment houses or hedge funds were under pressure to maintain the high returns of the 2000s. Since this makes up the majority of the market, there was significantly urgent need to see a major correction in the stock market. Hence we saw everyone get into the “cheap” market at once and continue bidding it up, often through leverage. There wasn’t much concern about risk or whether the stock appreciation was fundamentally supported because everyone required a certain rate of return and would chase it at any cost. Since housing didn’t supply these returns and the government flooding Big Finance with free money, everyone powered into the stock market at once and went back to 2006 leverage. This was able to produce a dramatic run despite a complete lack of economic support.

Eventually these things must come to an end and a dramatic buildup usually results in a painful crash. Quantitative easing is over, all the buyers are already in the market, and leverage is as high as can be. After a year without good economic news, people are starting to get impatient with the so called recovery. Massive bubbles in the biggest recovery areas like China and Brazil, so called immune countries like Australia and Canada, and bonds everywhere are becoming glaringly obvious. Big default implosions in smaller markets like Greece/Portugal/Iceland/Dubai/Latvia/Ukraine/Lithuania/Ireland/Spain/Italy/Argentina/Venezuela/Mexico are popping up and drawing international attention. This is leading to increased scrutiny of Japan, Russia, UK, and the United States (especially the states). With these factors dominating public attention, the market appears to have hit its top.

Compounding these trends are the behavior of bond market indicators. First let’s look at the US Treasury yield curve…

For all the talk of a recovery, the bond market just isn’t buying it. Short term Treasury bills are still hovering at nearly 0%. Longer term bills and bonds are still at low rates and are now exhibiting a downward trend as the dollar strengthens. With all the excess reserves and government liquidity floating around, yield would be through the roof if the bond market was anticipating any type of recovery. Instead they’re far below average yields and pushing downward even further. Since the bond market has historically been a much better economic indicator than stocks, it foreshadows negativity ahead.

Next let’s take a look at the overall risk in the market…

This is probably the best sign of the market as it currently sits. Even the most bullish economist would admit there’s still a lot of risk in the business world today. With credit declining, banks failing at record rates, and budget problems apparent everywhere, we hardly seem to have a favorable business environment. If I were to lend money to businesses rated riskier, I’d demand a much bigger return premium than almost any other time in modern history. Not the case as the chart above illustrates.

Except in the best of times, Baa corporate bonds require at least 7% yields and are often higher than this. In today’s climate, you sure wouldn’t expect to see 6.25%. You also wouldn’t expect to see a spread over 10 year Treasuries approaching levels as low as the height of the boom. This chart indicates there is a nearly unfathomable level of risk in capital markets today. This cannot be sustainable, especially without improved economic conditions. With commercial real estate in the midst of a complete collapse, another huge wave of foreclosures on the horizon, pension disasters popping up everywhere, and losses prepared to come from the bubbles listed above, I don’t think this level of risk (without the proper yields) is justifiable for much longer. All it will take is one major event (which we may see in Greece or Portugal very soon) to cause the House of Cards to come toppling down.

My theory is we’re in for a very tumultuous year and it will have severe consequences for capital markets. Like it did in 2009, it’s entirely possible the bubbles continue to inflate. It’s also possible we see stagnation rather than rocky behavior. I think this is unlikely due to a financial system with the same structural problems as last year, massive leverage everywhere, and the inability of most governments to operate as a backstop for losses.

Very soon, I will be unveiling a new feature on this website to strategically monitor this theory. My intention is to lay out the facts and my interpretation here and let all interested parties prepare accordingly. We’ve already seen the initial stages over the last two weeks of a new bear market. We’re seeing worse than expected economic reports. We’re seeing negative reaction to positive economic reports and earnings. We’re seeing big sell-offs at the end of each day’s market session. We’re seeing the news being dominated by more negative stories that have been brewing for a long time out of the mainstream eye. We’re seeing a return to the dollar/stock/commodity correlation and most people seek the light to safety of the dollar. I personally have taken note of these trends and reacted accordingly. I suggest everyone else examine their own situation carefully as well.

Economic events sure are heating up these days. Let’s take a closer look at some of the key indicators and reports of recent days.

A week ago, we saw a very positive GDP number. With all the talk of recovery, I’ve generally shrugged off better than expected numbers because they’re largely a reflection of government intervention. The 4th quarter GDP went beyond public support and actually had some positive signals. Let’s look at some of the highlights courtesy of the BEA News Release:

Real gross domestic product — the output of goods and services produced by labor and property
located in the United States — increased at an annual rate of 5.7 percent in the fourth quarter of 2009,
(that is, from the third quarter to the fourth quarter), according to the “advance” estimate released by the
Bureau of Economic Analysis. In the third quarter, real GDP increased 2.2 percent.

The Bureau emphasized that the fourth-quarter advance estimate released today is based on
source data that are incomplete or subject to further revision by the source agency (see the box on page
4). The “second” estimate for the fourth quarter, based on more complete data, will be released on
February 26, 2010.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from
private inventory investment, exports, and personal consumption expenditures (PCE). Imports, which
are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP in the fourth quarter primarily reflected an acceleration in private
inventory investment, a deceleration in imports, and an upturn in nonresidential fixed investment that
were partly offset by decelerations in federal government spending and in PCE.

Taking a closer look, 3.39 of the 5.7% (0r almost 60%) of the increase was due to restocking inventories. In my October economic outlook, I noted GDP would eventually turn positive because inventories were so seriously depleted and had to eventually be restocked. It appears most of this activity took place in the 4th quarter. While this was both predictable and mathematically inevitable, it’s still a positive sign to see it come to fruition. There will still probably be more to come in future quarters, and I’d expect this number to stay elevated over the next few quarters before resuming declines.

Beyond this number, there was very little noteworthy items. Government spending remains high but at its already lofty level had very little opportunity to increase further. Exports and imports both increased, although exports increased at a more rapid rate. Consumption increased very minimally.

I personally think this was a very good report and an encouraging sign for recovery. With that said, it’s far too soon to uncork the champagne because there was a lot to be skeptical about. In order for this growth to go beyond a government propped, business cycle surprise we have to see a recovery in consumption. Current consumption levels are only marginally better than 2008 levels and haven’t shown the increase we’d typically see in a recovery. We also saw a major slowdown in residential investment during Q4 and have yet to see any recovery in personal income. The positive signals simply appear transient datapoints following the major interruption of 2008-2009.

Next we go to today’s unemployment report courtesy of Bureau of Labor Statistics…

In January, the number of unemployed persons decreased to 14.8 million, and the unemployment rate fell by 0.3 percentage point to 9.7 percent. (See table A-1.)

In January, unemployment rates for most major worker groups–adult men (10.0 percent), teenagers (26.4 percent), blacks (16.5 percent), and Hispanics (12.6 percent)–showed little change. The jobless rate for adult women fell to 7.9 percent, and the rate for whites declined to 8.7 percent. The jobless rate for Asians was 8.4 percent, not seasonally adjusted. (See tables A-1, A-2, and A-3.)

This release includes new household survey tables with information about employment and unemployment of veterans, persons with a disability, and the foreign born. In January, the unemployment rate of veterans from Gulf War
era II (September 2001 to the present) was 12.6 percent, compared with 10.4 percent for nonveterans. Persons with a disability had a higher jobless rate than persons with no disability–15.2 versus 10.4 percent. In addition, the labor force participation rate of persons with a disability was 21.8 percent, compared with 70.1 percent for those without a disability. The unemployment rate for the foreign born was 11.8 percent, and the rate for the native born was 10.3 percent. (The data in these new tables are not seasonally adjusted.) (See tables A-5, A-6, and A-7.)

Now this report leaves me incredibly skeptical of the so called good headline results. We see a major contradiction in results as the unemployment rate drops from 10% to 9.7% despite a reduction in non farm payroll employees (-20,000). On top of this, we actually saw an increase in the labor force, which means jobs really had to grow to get to the 9.7% number. Now granted, the surveying methodology is different between unemployment rate and payroll data so there’s not some error or manipulation. The disturbing part is that unemployment rates are difficult to trust when every other data point suggest negative employment trends. Emergency claims continue increasing, initial claims are still above job growth levels, and non farm payroll is still declining. I trust these corroborating measures more than the unemployment rate personally.

On top of this, we see a tremendous gap in the seasonal adjustments. The non seasonally adjusted total unemployed people are 8.8% higher than the seasonally adjusted January numbers. This is not without historical precedent, as the number unemployed is almost always highest in January. Seasonal adjustments have also been done similarly in the past. The part I question is whether we should be using past assumptions to determine the seasonal adjustment amount now. The reason why January is typically a high unemployment month is because temporary holiday jobs are cut, while many businesses begin layoffs after year end figures don’t meet targets. In 2008, however, this trend reversed and the number kept shooting higher after January. With retail in perpetual contraction and most businesses in downsizing mode, I don’t think this year is merely a seasonal trend. As continuing and emergency claims data demonstrates, unemployed people are not finding new employment. I think the BLS models need to be updated to account for this factor rather than chalking up bad results to seasonality and assuming they will quickly find new jobs. If not, we’re in for quite an uptick in the next few months when seasonal adjustments work in the opposite direction.

Finally, in my unemployment forecast last month I predicted we’d see the work week increase and temporary hires be the lone bright spot in new employment. Both of these measures saw increases, which helps prove the 9.7% rate is not due to an upswing in business attitude toward hiring. Many believe this is a leading indicator, but I think it’s simply the start of a long lasting trend.

The most important economic indicator in the US economy is credit. Consumer credit guides both GDP and employment measures and should thus be the best indication of future trends. This is one of those few instances where the headline represents an accurate portrayal…

Consumer credit falls for 11th straight month

Consumer credit declined in December for the 11th straight month, but the pace slowed considerably, according to a government report released Friday.

Total consumer borrowing fell a seasonally adjusted $1.8 billion, an annual rate of 0.8%, to $2.456 trillion in December, according to the Federal Reserve.

Economists predicted a decline in total borrowing of $10 billion in December, according to a consensus survey from Briefing.com. November saw a downwardly revised 10.6% decrease, or $21.8 billion, in total consumer borrowing.

Maher said he expected November to be revised upward, but instead it was even more negative — so December’s more upbeat data “doesn’t mean we’re out of the woods.”

It’s time to take an updated look at my graph of consumer credit…

In October I stated credit would need to continue falling until it made it closer to the sustainable trend line. As you can see, despite having fallen 12 consecutive months, it has a long way to go. The fact that this is occurring essentially means a V shaped recovery is impossible but I think it’s good to see these results. Despite all the government action to prevent this correction, it is happening nonetheless. As soon as we near the trend line, the economy can embark on a more meaningful recovery process. Long term, this indicator is very good, however, it will cause much hardship in the short term as the economy purges its excess.

Even though economic reports are plentiful, I thought these were three important trends to analyze in greater detail. Tomorrow I will take a look at capital markets and see how they represent the core economic trends, while forecasting where we go from here.

You’ve seen The Biggest Loser captivate the nation with its stories of desire, triumph, struggle, and the realization of dreams. You’ve seen motivation at its extreme as individuals cope with the formidable task of battling their deepest urges in hope of realizing the hidden courage within. From our Hollywood studios we bring you something never seen before on tv or even reality. If you think you’ve seen valor, well let me assure you, you’ve seen nothing yet. We proudly introduce you, The Biggest Loser: State Government Edition!

This season will feature ten teams of contestants striving to accomplish the impossible: trim the fat from their butt, excuse me, budgets. For years, these contestants have been unable to control the desperate urges of excess. Back in the 80’s, consuming more was just the means to a healthy subsistence. After all, balance was theoretically sensible but expansion was just so much easier, so much more satisfying in the short term. What seemed like an inconsequential binge escalated into pattern, and pattern escalated into something even greater. However, how could this be wrong?… everyone else was doing it! As we sit hear today, we find these contestants on the verge of breaking the backbone of their own greatness. Only on this reality sensation will you see these ten contestants break the trends and adhere to a new regiment of responsibility. Let’s meet your cast:

- Governor Arnold Schwarzenegger (California):

“People loved me as the big, heartless Terminator. If I’m going to win this competition, let the mass, heartless termination begin.”

- Governor Pat Quinn (Illinois):

“When I keep telling my constituents I’ll definitely, 100% be the biggest loser this year, everyone keeps nodding and smiling at me. What a great bunch of support! Some have even commemorated my confidence by giving me a Chicago Cubs shirt to make the best representation possible.”

- Governor David Paterson (New York):

“We all know us New Yorkers are bound to win. Remember, I’m the one that fought for those fast food taxes.”

- Governor Ted Kulongoski (Oregon):

“If I had to summarize this whole process in a few words, I’d say ’solving our problem is taxing’.”

- Governor Chris Christie (New Jersey):

“I plan to exercise. our right to greater discipline.”

- Governor Jan Brewer (Arizona):

“Holding this competition in the winter? This is our time to shine!”

- Governor Jim Douglas (Vermont):

“I just hope the measures we personally take in this show don’t lead to the bankruptcy of Vermont staple Ben & Jerry’s. Gosh, we’ve single handedly provided a nice subsidy to their bottom line.”

- Governor Jennifer Granholm (Michigan):

“I’ve been studying the Japanese very closely because they’re an expert on everything we do in the great state of Michigan! Union bylaw 6.7c might make this whole downsizing effort pretty tough though.”

- Governor Jim Gibbons (Nevada):

“The people of Nevada are willing to set an example and tighten their belts. The buffet line at the Bellagio sure was short yesterday.”

- Governor Ted Strickland (Ohio):

“If the recent presidential elections taught us anything it’s that how goes Ohio, goes the country. Oh crap, I saw that budget… that means we have a lot of work to do. Is this camera on?”

Excited? We sure are… coming this spring to NBC.*

* Pending sale to Comcast. If this deal falls apart, GE will instead be airing The Apprentice: Treasury Department edition

As I work on some interesting upcoming posts, I want to share a few items I found interesting during the day. I started with yesterday’s post illustrating a changing sentiment in international trade. However, with such an unprecedented economic upheaval, there was bound to be significant changes in attitudes. Let’s examine…

Health-Care Burden Shifts to U.S. Government as Spending Soars

Health-care spending in the U.S. will almost double in 2019 to $4.5 trillion, or more than 19 percent of the economy, as unemployment and aging baby boomers drive up government costs, economists forecast.

Spending already jumped to $2.5 trillion, or 17.3 percent of the economy, in 2009, the economists from the U.S. Centers for Medicare and Medicaid Services said in their yearly estimate, published today in the journal Health Affairs. The increase in share of gross domestic product, from 16.2 percent in 2008, was the biggest since record keeping began in 1960.

The analysts, whose agency manages the government’s largest health-insurance programs, said their 11-year projections reflect “the influence of the recession” that began in December 2007 and the aging of the generation born from 1946 to 1964, the post-World War II population surge known as the baby boom. The projections don’t include the impact of a proposed health-care overhaul, which is stalled in Congress.

Here’s an interesting article about the so called recovery….

Fading trading

There are two worries to spoil this improving picture. One is what happened after the third quarter. Mr Hoekman believes that there was a “distinct slowdown” in the pace of recovery towards the end of 2009. Preliminary figures suggest that the volume of world trade expanded by just 1.1% in November, less than the October increase of 1.4% and much less than the 5.4% rise in September. The bank reckons that the value of world trade (which is also affected by price and exchange-rate fluctuations) fell slightly in November. A rebound in shipments in and out of some of the world’s busiest ports also faded (see chart). Why would the resurgence have fizzled? The best explanation is that third-quarter growth was buoyed by the rebuilding of inventories, which were slashed in the depths of the crisis. That effect may have ebbed.

The global trade statistics paint a very clear picture of what the global economy is dealing with. In 2008-1Q2009 there was record levels of contraction. At this point every country enacted their own stimulus measures, with the most notable being China. It was obvious things had to improve off record lows and since the governments decided to do the bidding, things appeared to be improving. Combine this with inventory restocking and you have what appears to be growth. In the fourth quarter of 2009, we began to see these measures failing to improve the most fundamental measures and resorting to Plan B (protectionism). Now we’re at the stage where stimulus measures are set to run out and all the hidden problems will slowly re-emerge. There’s no surprise behind these numbers and we will see it spread to capital markets, deflation readings, real estate, and GDP before long. The W shaped recession is looking more likely by the day (except it will likely be a www shape).

I really have no desire to go through the budget and perform a detailed analysis because there will be no significant changes until Social Security, Medicare, and military spending are addressed. Likewise, I have no confidence in government to avoid spending trillions more on bailouts, lending programs, job creation fallacies, and other so called stimulus measure. I predict the 2010 budget will ultimately require several “surprises”  including state bailouts, additional infusions into the FHA/FDIC/Fannie/Freddie, and probably some other economic recipes from Chef Obama & Company. Whatever the Obama administration proposed today doesn’t require much reading- the cards are already showing for all to see. The USA Today recently had a nice writeup on this topic…

The U.S. is broke. Here’s why.

Trouble is, the deficit is only a symptom of a chronic disease that strikes at the very heart of democratic government.

The disease? Fiscal sclerosis — setting future national priorities in stone long before the future has arrived. Our fiscal arteries are so clogged and hardened that to do anything new, meet any emergency, or engage any new opportunity, the president must renege on past legislators’ promises regarding Medicare, Medicaid, Social Security and other such entitlement programs. If he doesn’t address unsustainable promises head-on, Obama will have no wiggle room in the budget for the rest of his presidency, and government will be tied up with yesterday’s problems and the demands of yesterday’s voters.

Thanks to decades of promises for ever-higher benefits and low taxes for the indefinite future, there’s now less give in future budgets than at any point in American history. At least profligate Congresses in the past confined their excesses and temporarily large deficits to the current year. Until recently, they didn’t box in the future…

For the first time in U.S. history, in 2009 every single dollar of revenue was committed before Congress voted on any spending program. Meanwhile, most of government’s basic functions — from justice to education to turning on the lights in the Capitol — are paid for out of swelling, unsustainable deficits.

Blame the recession for some of this dip. But even a recovery only temporarily restores a bit of financial freedom, not enough to reverse the downward trend.

No more annual appropriations are needed to fuel this vicious cycle. On our current path, Rip Van Congress could take a 50-year snooze, and the entire budget (and then some!) would still be spoken for. Tax revenues would rise with economic growth, but not as fast as spending and deficits.

Not only are we in budget talks but also have the joys of election season. I am disgusted by how many of these so called “small government reformers” were the same people engaged in the same nonsense from the USA Today article. I’m no defender of today’s governing because they’re repeating exactly the same mistakes of yesterday. I’m just tired of the non-productive criticism from the same people that supported the Iraq War, Medicare Part D, and TARP to name a few. These people didn’t suddenly get a fiscal responsibility epiphany, they just realized it would help their re-election bids (as those commercials keep reminding me). My point is not to deride the usual political posturing as this is far too easy. It’s to reiterate my analysis that the budget is not about the overall number or size of the deficit. We need to demand changes where change will be meaningful and this is just not happening. I’ll repeat: at the federal level it is entitlement programs and military spending. At the state/local level it is pension reform and Medicaid.  Since these issues have received zero attention from anybody, the following has become inevitable…

Some Good News Amid Tax Increases

President Barack Obama’s budget proposes to help narrow a yawning budget deficit by doing away with some sweeping Bush administration tax cuts for the wealthy.

Mr. Obama had planned tax increases for those earning more than $250,000 in last year’s budget, but they didn’t happen. However, action is more likely this time because tax cuts from the George W. Bush-era expire at the end of the year unless Congress extends them.

The budget contains some carrots for taxpayers. One popular move will be to eliminate personal taxes on employer-provided cellphones.

Click the link to get more specifics on the tax proposals. These tax changes are not welcomed but inevitable. They are relatively tame compared to what is bound to come. Every budget over the next several years will become a controversial issue because they will come with more and more tax increases. If you plan to vote in the primary elections or intend to become politically active, stop for a minute and consider the nonsense. If you happen to talk to a candidate, flat out tell them what needs to be done and what the consequences will be for inaction or less than genuine rhetoric. Otherwise these budget discussions are nothing more than a repeat of USA Today’s example.

I’ve vehemently declared my opposition to the federal stimulus plans and wasteful state construction projects. On the contrary, I’ve always stated I don’t mind government investment in vital infrastructure projects, scientific initiatives, or national security related expenditures. Hence I support targeted, intelligent alternative energy spending because I feel it adds value to our nation, while bolstering national security efforts. Look back on history and Eisenhower’s Interstate Highway System or Kennedy’s NASA program come to mind as worthwhile government investments. When Obama announced funding for a new high speed rail project, I had one of those rare moments when I said, “Wow, now this can actually be an instance of positive government action.”

For those unfamiliar with this projects, Time does a nice summary of the proposal and its pros and cons… (probably worth a read in its entirety)

Can High-Speed Rail Succeed in America?

“We want to start looking deep into the 21st century and say to ourselves, There’s no reason why other countries can build high-speed rail lines and we can’t,” Obama told a crowd in a University of Tampa arena. “Right here in Tampa, we’re building the future.”

That’s a nice sentiment, but America’s antiquated rail system will have to advance a long way just to make it to the present, let alone the future. U.S. intercity railroads are a laughingstock compared with those in most other developed nations — and, increasingly, even those in developing nations like China, which is investing more than $300 billion to build more than 16,000 miles of high-speed track by 2020.

Today you can travel the 250 miles from Paris to Lyon on the high-speed TGV in two hours. Covering a similar distance from Philadelphia to Boston takes some five hours, and that’s on an Amtrak Acela train, the closest thing the U.S. has to high-speed rail. “Every other major industrialized nation has recognized that high-speed rail is key to economic growth and mobility,” says Petra Todorovich, director of the America 2050 program at the Regional Planning Association. “It’s time for America to realize that as well.”…

Still, the initial round of $8 billion — which Biden referred to as “seed money” during his remarks in Tampa — is just a tiny percentage of what it would cost to significantly overhaul the country’s rail system. And there are concerns that by spreading the funds to so many different projects in so many different states, it won’t be possible to make a real difference in any one place, as Mark Reutter wrote in a new report for the Progressive Policy Institute. It doesn’t help that the one region that could most obviously benefit from truly high-speed rail — the Boston-to-Washington corridor — received a mere $112 million in funding, in part because building new track in the congested area would be prohibitively expensive and politically challenging.

I’ve received some feedback, questions, and arguments against yesterday’s post. If you haven’t yet read the post, I urge you to scroll down a little bit and read this first. I’ll go argument by argument on this one…

This cannot work- you’ll just increase the wage disparity between rich and poor!

On face, it might appear this is the case. After all if you allow the lowest wages to decrease, mathematically the disparity grows. First, I would argue that the wage disparity has never been higher. Right now, you have 10% of the population making $0 income because they have no job. You have another 7% of the population unable to work as many hours as they are willing to supply. Implement Rockwell’s solutions and those numbers are eliminated and mathematically the disparity has to go down. In addition, two years ago at 5% unemployment still had the largest income disparity in US history (because of this intervention).

So what would happen if you eliminated price controls on wages? Yes, wages would go down for those working by the hour or in an unskilled profession. The important thing to note, however, is the wage would be determined by the equilibrium point where the worker believes the wages are good enough that working outweighs not working. Therefore, it’s not going to escalate down to third world levels because nobody can survive in this country on say $1/hour.

Now remember, the average American household makes approximately $50,000 annually. Assume with these changes, the average income drops to $40,000. This means people are able to pay less for goods and services. Businesses will have to lower prices or will go out of business. This will affect profitability and businesses will have to cut the salaries of its higher paid workers to even things out. Since they are paying less overall wages, it will even itself out at their bottom line. This is how an efficient market works. It doesn’t matter how much money you’re making, but how much that money can buy you. Lower wages across the board causes no net change to purchasing power.

I just don’t buy that upper income workers will be affected!

Ok, what is an upper income worker? They are people who own businesses. They are people at the top of the corporate ladder. They are professionals like doctors, lawyers, and engineers. If exactly half the population (say those below $50k) is affected, there is simply not enough willingness from companies to keep higher income at the same level. Look at the most successful American corporations. Wal-Mart caters to those looking for the lowest prices. Exxon-Mobil sells the same quantity of fuel to people regardless of their income level. Google depends on the advertising demand of the masses. Ford sells more auto models below $30,000 than above. You cannot lower the income base of half the population without adversely affecting their bottom line. If these companies see their profits go down, they will lower their largest expenses. This will lower their highest paid employee’s incomes, and affect the price they’re willing to pay to suppliers. As this goes up and down the economy, it will inevitably lead to lower income for all but no net change in purchasing power.

In today’s political environment, these changes cannot possibly be made!

This may be true, but I don’t think it is impossible. I think it will just happen much slower than anticipated because powerful interest want to maintain status quo. The fact remains, however, that unemployed workers want work now. Many are unemployed because they have an unrealistic expectation of what employers will pay them. They’re still living on the belief that the economy will recover and things will go back to the way they are. This will never happen because credit conditions will never be as elevated as they once were. Say these people are unemployed for a year… suddenly they’ll take any work that allows them to feed their family. This is why we see PhDs taking jobs behind the retail counter. This is why we see union employment being affected worse. Eventually, workers will demand work at the equilibrium price and employers will be more than happy to supply it. Market forces can push towards these solutions and hopefully create the political will to lift these barriers. Based on trends, the public has no appetite for more government intervention (like the stimulus plan). Eventually they will realize less government is best.

Can we solve this with tax cuts?

These tax cuts might spur the economy short term and temporarily reduce unemployment. However, once the money is spent and taxes inevitably have to rise (and they do unfortunately) it goes right back to the structural problems we have today. Keep in mind, manufacturing jobs have been declining for a long time now and have been largely replaced by construction and retail jobs. Now that construction and retail have reached a point far above sustainability, we have to fill those jobs somewhere. Thus no matter what short term efforts are applied, it will do nothing to fix the structural problems.

What are these structural problems? It’s a world where the supply and demand of labor cannot hit an equilibrium point which leads to a market price. Labor intervention has become so deep and ingrained that it’s creating the equivalent of a price floor. Remember my example on real estate… if you lower the price of your house enough, eventually you’ll have a surplus of buyers. Keep prices of real estate high enough (like they are today) and you’ll have a shortage of buyers.

The labor market is no different. Flood the market with more money and it might create a short term illusion that creates incentives for some hiring. Where unemployment will be solved for the long term is where there is allowed to be an equilibrium between the supply workers are willing to supply and the employment businesses are willing to provide. Government can keep housing prices artificially high through tax credits but won’t get the market truly moving until housing equilibrium is hit. The labor market is no different.