Some Comments

I have quoted the CHOICE Asset Management Team before. I will try to not do it too much given how sarcastic they tend to be, but I thought the following comments were fitting.

"The 5.4 billion share Citigroup offering designed to repay TARP did not go particularly well for taxpayers, who actually came out of the botched secondary (was priced 20% below prevailing prices the day prior to the deal’s announcement, pushing the offering below the government’s $3.25 cost and thwarting plans to sell 1 billion of our shares) with more restrictions on our stock than we had going in (can’t sell for 90 days, and don’t forget that our common-share stake originally came in the form of a more-senior interest-bearing preferred). We still own 7.7 billion shares (“down” from a 34% to a 27% stake in the company due to the share dilution), but the bank that never sleeps can pay bonuses in 2010 now, hoo-ray!"

"The IRS and Treasury did what they could to help the deal, by giving it an exception for longstanding change-of-ownership rules that “would have” eliminated the value of Citi’s $38 billion of tax loss carry-forwards. Didn’t Mr. Obama just a week ago say something about getting tough on “fat cat bankers”? (Recall that C employs 46 full time lobbyists, more than any other company – Mr. “Whatever it takes” Geithner may have missed 60 Minutes that night.)"

"Today Bloomberg is running a story mentioning that C shares need to at least triple by 2018 for the warrants that taxpayers own to have any value (we own 255 million warrants to buy stock at $10.61/share and another 210 million at $17.85/share). The latter would give it a half-trillion market capitalization, more than what any US bank has ever achieved."

"We should note that Wells Fargo’s $10.7 billion offering appeared to go off without a hitch (and probably contributed to buyer indigestion for Citi), allowing it to repay its $25 billion loan from taxpayers."

"That occurred even as Citigoup and Wells Fargo repaid their respective $20 and $25 billion TARP borrowings to the US Treasury (taxpayers)."

"Positive as that is, we hope Americans can see through officials’ curious assessment that TARP has been “profitable,” since taxpayer “investments” in AIG, Fannie Mae, and Freddie Mac (among others) have expanded, rather than contracted. In referring to TARP “profits,” officials are ignoring unrealized losses on AIG, Fannie Mae, and Freddie Mac. Using the same logic, an investor might declare his or her portfolio to be “profitable,” provided they excluded underwater positions they still own in their portfolio."

"The Treasury announced it is lifting its $400 billion cap to support Fannie Mae and Freddie Mac, and now will provide “unlimited” support, likely signaling that mortgage losses are set to grow in 2010. Treasury said its announcement “should leave no uncertainty about Treasury’s commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”

"The same day, Fannie and Freddie announced its chief executives would receive $6 million in remuneration for 2009, a year in which both firms lost billions of dollars and required taxpayer support to remain solvent."

"Was the timing of these announcements on Christmas Eve merely a coincidence, or was the timing strategically designed so that the news would get “lost” over a long weekend, in which Americans were focused on family, friends, and the holiday season? You know the answer."

"Does anyone recognize that Treasury is conducting fiscal policy, which once (see Article 1, Section 7 of the US Constitution) was thought to be Congress’ responsibility?"

IRAN

This very long, but important, article makes me feel warm and cozy all over. (Insert dripping sarcasm graphic here).

The Iranian Incursion in Context
By George Friedman

A small number of Iranian troops entered Iraq, where they took control of an oil well and raised the Iranian flag Dec. 18. The Iranian-Iraqi border in this region is poorly defined and is contested, with the Iranians claiming this well is in Iranian territory not returned after the Iran-Iraq War. Such incidents have occurred in the past. Given that there were no casualties this time, it therefore would be easy to dismiss this incident, even though at about the same time an Iranian official claimed that Iraq owes Iran about $1 trillion in reparations for starting the Iran-Iraq War.

But what would be fairly trivial at another time and place is not trivial now.

Sending a Message With an Incursion
Multiple sources have reported that Tehran ordered the incident. The Iranian government is aware that Washington has said the end of 2009 was to be the deadline for taking action against Iran over its nuclear program — and that according to a White House source, the United States could extend that deadline to Jan. 15, 2010.

That postponement makes an important point. The United States has treated the Iran crisis as something that will be handled on an American timeline. The way that the Obama administration handled the Afghanistan strategy review suggests it assumes that Washington controls the tempo of events sufficiently that it can make decisions carefully, deliberately and with due reflection. If true, that would mean that adversaries like Iran are purely on the defensive, and either have no counter to American moves or cannot counter the United States until after Washington makes its next move.

For Iran, just to accept that premise puts it at an obvious disadvantage. First, Tehran would have to demonstrate that the tempo of events is not simply in American or Israeli hands. Second, Tehran would have to remind the United States and Israel that Iran has options that it might use regardless of whether the United States chooses sanctions or war. Most important, Iran must show that whatever these options are, they can occur before the United States acts — that Iran has axes of its own, and may not wait for the U.S. axe to fall.

The incursion was shaped to make this point without forcing the United States into precipitous action. The location was politically ambiguous. The force was small. Casualties were avoided. At the same time, it was an action that snapped a lot of people to attention. Oil prices climbed. Baghdad and Washington scrambled to try to figure what was going on, and for a while Washington was clearly at a loss, driving home the fact that the United States doesn’t always respond quickly and efficiently to surprises initiated by the other side.

The event eventually died down, and the Iranians went out of their way to minimize its importance. But two points nevertheless were made. The first was that Iran might not wait for Washington to consider all possible scenarios. The second was that the Iranians know how to raise oil prices. And with that lesson, they reminded the Americans that the Iranians have a degree of control over the economic recovery in the United States.

There has never been any doubt that Iran has options in the event that the United States chooses to strike. Significantly, the Iranians now have driven home that they might initiate a conflict if they assume conflict is inevitable.

U.S. and Iranian Options
Iran’s problem becomes clear when we consider Tehran’s options. These options fall into three groups:
1. Interdicting the flow of oil through the Strait of Hormuz and Persian Gulf through the use of mines and anti-ship missiles. This would result in a dramatic increase in world oil prices on the Iranian attempt alone and could keep them high if Tehran’s efforts succeeded. The impact on the global economy would be substantial.

2. Causing massive destabilization in Iraq. The Iranians retain allies and agents in Iraq, which has been experiencing increased violence and destabilization over the past months. As the violence increases and the Americans leave, a close relationship with Iran might be increasingly attractive to Iraqi troops. Given the deployment of American troops, direct attacks in Iraq by Iranian forces are not out of the question. Even if ultimately repulsed, such Iranian incursions could further destabilize Iraq. This would force the Obama administration to reconsider the U.S. withdrawal timetable, potentially affecting Afghanistan.

3. Use Hezbollah to initiate a conflict with Israel, and as a global tool for terrorist attacks on American and allied targets. Hezbollah is far more sophisticated and effective than al Qaeda was at its height, and would be a formidable threat should Iran choose — and Hezbollah agree — to play this role.

When we look at the three Iranian options, it is clear that the United States would not be able to confine any action against Iran to airstrikes. The United States is extremely good at air campaigns, while it is weak at counterinsurgency. It has massive resources in the region to throw into an air campaign and it can bring more in using carrier strike groups.

But even before hitting Iran’s nuclear facilities, the Americans would have to consider the potential Iranian responses. Washington would have to take three steps. First, Iranian anti-ship missiles and surface vessels — and these vessels could be very small but still able to carry out mine warfare — on the Iranian littoral would have to be destroyed. Second, large formations of Iranian troops along the Iraqi border would have to be attacked, and Iranian assets in Iraq at the very least disrupted. Finally, covert actions against Hezbollah assets — particularly assets outside Lebanon — would have to be neutralized to the extent possible.

This would require massive, coordinated attacks, primarily using airpower and covert forces in a very tight sequence prior to any attack on Iran’s nuclear facilities. Without this, Iran would be in a position to launch the attacks outlined above in response to strikes on its nuclear facilities. Given the nature of the Iranian responses, particularly the mining of the Persian Gulf and Strait of Hormuz, the operations could be carried out quickly and with potentially devastating results to the global economy.

From the Iranian standpoint, Tehran faces a “use-it-or-lose-it” scenario. It cannot wait until the United States initiates hostilities. The worst-case scenario for Iran is waiting for Washington to initiate the conflict.

At the same time, the very complexity of an Iranian attack makes the United States want to think long and hard before attacking Iran. The opportunities for failure are substantial, no matter how well the attack is planned. And the United States can’t allow Israel to start a conflict with Iran alone because Israel lacks the resources to deal with a subsequent Iranian naval interdiction and disruptions in Iraq.

It follows that the United States is interested in a nonmilitary solution to the problem. The ideal solution would be sanctions on gasoline. The United States wants to take as much time as needed to get China and Russia committed to such sanctions.

Iranian Pre-emption
The Iranians signaled last week that they might not choose to be passive if effective sanctions were put in place. Sanctions on gasoline would in fact cripple Iran, so like Japan prior to Pearl Harbor, the option of capitulating to sanctions might be viewed as more risky than a pre-emptive strike. And if sanctions didn’t work, the Iranians would have to assume a military attack is coming next. Since the Iranians wouldn’t know when it would happen, and their retaliatory options might disappear in the first phase of the military operation, they would need to act before such an attack.

The problem is that the Iranians won’t know precisely when that attack will take place. The United States and Israel have long discussed a redline in Iranian nuclear development, which if approached would force an attack on Iran to prevent Tehran from obtaining nuclear weapons. Logically, Iran would seem to have a redline as well, equally poorly designed. At the point when it becomes clear that sanctions are threatening regime survival or that military action is inevitable, Iran must act first, using its military assets before it loses them.

Iran cannot live with either effective sanctions or the type of campaign that the United States would have to launch to take out Iran’s nuclear facilities. The United States can’t live with the consequences of Iranian counteractions to an attack. Even if sanctions were possible, they would leave Iran with the option to do precisely those things Washington cannot tolerate. Therefore, whether the diplomatic or military route is followed, each side has two options. First, the Americans can accept Iran as a nuclear power, or Iran can accept that it must give up its nuclear ambitions. Second, assuming that neither side accepts the first option, each side must take military action before the other side does. The Americans must neutralize counters before the Iranians deploy them. The Iranians must deploy their counters before they are destroyed.
The United States and Iran are both playing for time. Neither side wants to change its position on the nuclear question, although each hopes the other will give in. Moreover, neither side is really confident in its military options. The Americans are not certain that they can both destroy the nuclear facilities and Iranian counters — and if the counters are effective, their consequences could be devastating. The Iranians are not certain that their counters will work effectively, and once failure is established, the Iranians will be wide open for devastating attack. Each side assumes the other understands the risks and will accept the other’s terms for a settlement.

And so each waits, hoping the other side will back down. The events of the past week were designed to show the Americans that Iran is not prepared to back down. More important, they were designed to show that the Iranians also have a redline, that it is as fuzzy as the American redline and that the Americans should be very careful in how far they press, as they might suddenly wake up one morning with their hands full.

The Iranian move is deliberately designed to rattle U.S. President Barack Obama. He has shown a decision-making style that assumes that he is not under time pressure to make decisions. It is not clear to anyone what his decision-making style in a crisis will look like. Though not a prime consideration from the Iranian point of view, putting Obama in a position where he is psychologically unprepared for decisions in the timeframe they need to be made in is certainly an added benefit. Iran, of course, doesn’t know how effectively he might respond, but his approach to Afghanistan gives them another incentive to act sooner than later.

There are some parallels here to the nuclear warfare theory, in which each side faces mutual assured destruction. The problem here is that each side does not face destruction, but pain. And here, pre-emptive strikes are not guaranteed to produce anything. It is the vast unknowns that make this affair so dangerous, and at any moment, one side or the other might decide they can wait no longer.

"This report is republished with permission of STRATFOR"

Stimulus

My brother-in-law Tom made a comment on my last post that I totally agree with and have also been wondering for a while. His point was, how come none of our representatives seem to remember Econ 101? Further we can ask, why is it they don't seem to pay attention to any of the current studies? You would think that at the very least one of their many aides would have read something that completely contradicts what they are working on.

I think that this article from Greg Mankiw is yet another example of something you hope that our representatives read and, more importantly, take into consideration as they are looking at policy changes.

Tax Cuts Might Accomplish What Spending Hasn’t
By N. GREGORY MANKIW

IMAGINE you are a physician and a patient arrives in your office with a troubling and mysterious disease. Some of the symptoms are familiar, but others are not. You have never treated anyone with quite this set of problems.

Based on your training and experience, imperfect as it is, you come up with a proposed remedy. The patient leaves with a prescription in hand. You hope and pray that it works.
A week later, however, the patient comes back and the symptoms are, in some ways, worse. What do you do now? You have three options:

STAY THE COURSE Perhaps the patient was sicker than you thought, and it will take longer for your remedy to kick in.

UP THE DOSAGE Perhaps the remedy was right but the quantity was wrong. The patient might need more medicine.

RETHINK THE REMEDY Perhaps the treatment you prescribed wasn’t right after all. Maybe a different mixture of medicines would work better.

Choosing among these three reasonable courses of action is not easy. In many ways, the Obama administration faces a similar situation right now.

When President Obama was elected, the economy was sick and getting sicker. Before he was even in office in January, his economic team released a report on the problem.
If nothing was done, the report said, the unemployment rate would keep rising, reaching 9 percent in early 2010. But if the nation embarked on a fiscal stimulus of $775 billion, mainly in the form of increased government spending, the unemployment rate was predicted to stay under 8 percent.

In fact, the Congress passed a sizable fiscal stimulus. Yet things turned out worse than the White House expected. The unemployment rate is now 10 percent — a full percentage point above what the administration economists said would occur without any stimulus.
To be sure, there are some positive signs, like reduced credit spreads, gross domestic product growth and diminishing job losses. But the recovery is not yet as robust as the president and his economic team had originally hoped.

So what to do now? The administration seems most intent on staying the course, although in a speech Tuesday, the president showed interest in upping the dosage. The better path, however, might be to rethink the remedy.

When devising its fiscal package, the Obama administration relied on conventional economic models based in part on ideas of John Maynard Keynes. Keynesian theory says that government spending is more potent than tax policy for jump-starting a stalled economy.

The report in January put numbers to this conclusion. It says that an extra dollar of government spending raises G.D.P. by $1.57, while a dollar of tax cuts raises G.D.P. by only 99 cents. The implication is that if we are going to increase the budget deficit to promote growth and jobs, it is better to spend more than tax less.

But various recent studies suggest that conventional wisdom is backward.
One piece of evidence comes from Christina D. Romer, the chairwoman of the president’s Council of Economic Advisers. In work with her husband, David H. Romer, written at the University of California, Berkeley, just months before she took her current job, Ms. Romer found that tax policy has a powerful influence on economic activity.

According to the Romers, each dollar of tax cuts has historically raised G.D.P. by about $3 — three times the figure used in the administration report. That is also far greater than most estimates of the effects of government spending.

Other recent work supports the Romers’ findings. In a December 2008 working paper, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago apply state-of-the-art statistical tools to United States data to compare the effects of deficit-financed spending, deficit-financed tax cuts and tax-financed spending. They report that “deficit-financed tax cuts work best among these three scenarios to improve G.D.P.”

My Harvard colleagues Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed.

The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending.

All these findings suggest that conventional models leave something out. A clue as to what that might be can be found in a 2002 study by Olivier Blanchard and Roberto Perotti. (Mr. Perotti is a professor at Boccini University in Milano, Italy; Mr. Blanchard is now chief economist at the International Monetary Fund.) They report that “both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is difficult to reconcile with Keynesian theory.”

These studies point toward tax policy as the best fiscal tool to combat recession, particularly tax changes that influence incentives to invest, like an investment tax credit. Sending out lump-sum rebates, as was done in spring 2008, makes less sense, as it provides little impetus for spending or production.

LIKE our doctor facing a mysterious illness, economists should remain humble and open-minded when considering how best to fix an ailing economy. A growing body of evidence suggests that traditional Keynesian nostrums might not be the best medicine.

Jobs

Now with everyone focused on the jobs front I wanted to share a few of my thoughts as I've read the headlines.

First, I thought that Jobs were supposed to be the focus the whole time? Wasn't that what the point of the second stimulus (the first under President Obama) was for? I thought that was the whole promise of we will create - adding in later the whole bit about saving - millions of jobs in less than a year. That's not to say I am bothered by their sudden turn, again, to the jobs focus, I just found it interesting that some in the media are portraying this as President Obama's first attempt.

Second, I like the points made by John Mauldin in his newsletter:

"In the '50s through the early '80s, recessions were typified by large layoffs at manufacturing businesses, as they had built up too much inventory. Businesses had increased capacity and often borrowed a little too much. Rising prices in the '70s, along with extremely high interest-rate costs, led to the two severe recessions of the early '80s, which Paul Volcker had to essentially force into existence, in order to begin the process of wringing inflation out of the economy.

"But, and this is important, as the economy improved, inventories were eventually worked through and employees were brought back to work. Things returned to normal. The economy would once again grow at a robust rate. Then, in the last two recessions, in the early '90s and early '00s, it took longer for employment to rise. A great part of this was because the manufacturing sector of national employment was becoming an ever smaller part of the economic pie. We were, and still are, turning into an economy driven by services.

"I should note that, on an absolute basis, manufacturing in the US has grown (going back to before this recession started.) We just produced more "stuff" with fewer employees. We became more productive. But this means that there are fewer jobs that will be brought "back" to make up for increasing sales than in past recessions. There are estimates out that as many as 2 million of the 8 million jobs lost are permanent job losses.

"We know that businesses have made large cuts in numbers of employees in order to address lower sales and to increase their profits. Increasing profits by cutting costs even as the "top-line" sales number is shrinking is not a growth strategy that can be sustained. It also eats into research and development and postpones growth."

In other words, if we are going to focus on jobs then we have to do so realistically. If 2 million jobs were permanently lost then how are we going to allow and encourage the creation of 2 million new jobs? We all know that students are currently being prepared for jobs that don't currently exist. There are tons of ideas out there which we don't even know are possibilities at this point.

I think all of this brings up my main point: The real question that government should be asking itself as it tries to come up with ideas on job creation is - In what ways can we get out of the way of job creation in the private sector? I think that they would all do well to read Gallup's World Poll studies on how "Brain Gain" works and more importantly right now (since we are beginning to experience this) how to avoid "Brain Drain."

I am slightly encourage to see some Supply-Side rhetoric coming from President Obama's recent speeches. However, I am not dumb enough to think that the current legislative body will follow through even on the tiniest bit of what could and should happen to get government out of the way. I think that our only hope for new jobs will be for the Legislature to change this coming election.

Here Come the Higher Taxes

"A government big enough to give you everything you want, is strong enough to take everything you have."
-Thomas Jefferson

Wouldn't it be great if the above quote, and especially its meaning, could be engrained in every voters head before they cast their vote? Sure it sounds nice that the government is promising cheaper healthcare for the poor (in the current bill the rich - middle class and up will pay for it), but at some point realistic goals and budgets have to be set.

Next thing we know they'll be proposing chocolate milk in the drinking fountains paid for by the "rich" because it is the "right" of every poor American to have a daily dose of calcium filled euphoria (yes, I like chocolate milk).

Wave of Debt Payments Facing U.S. Government
By Edmund L. Andrews, the New York Times

WASHINGTON — The United States government is financing its more than trillion-dollar-a-year borrowing with i.o.u.'s on terms that seem too good to be true.

But that happy situation, aided by ultralow interest rates, may not last much longer.
Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.
Even as Treasury officials are racing to lock in today's low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House estimates that the government's tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means.

The surge in borrowing over the last year or two is widely judged to have been a necessary response to the financial crisis and the deep recession, and there is still a raging debate over how aggressively to bring down deficits over the next few years. But there is little doubt that the United States' long-term budget crisis is becoming too big to postpone.

Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.

The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.

"The government is on teaser rates," said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits. "We're taking out a huge mortgage right now, but we won't feel the pain until later."

So far, the demand for Treasury securities from investors and other governments around the world has remained strong enough to hold down the interest rates that the United States must offer to sell them. Indeed, the government paid less interest on its debt this year than in 2008, even though it added almost $2 trillion in debt.

The government's average interest rate on new borrowing last year fell below 1 percent. For short-term i.o.u.'s like one-month Treasury bills, its average rate was only sixteen-hundredths of a percent.

"All of the auction results have been solid," said Matthew Rutherford, the Treasury's deputy assistant secretary in charge of finance operations. "Investor demand has been very broad, and it's been increasing in the last couple of years."

The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security. The nation's oldest baby boomers are approaching 65, setting off what experts have warned for years will be a fiscal nightmare for the government.

"What a good country or a good squirrel should be doing is stashing away nuts for the winter," said William H. Gross, managing director of the Pimco Group, the giant bond-management firm. "The United States is not only not saving nuts, it's eating the ones left over from the last winter."
The current low rates on the country's debt were caused by temporary factors that are already beginning to fade. One factor was the economic crisis itself, which caused panicked investors around the world to plow their money into the comparative safety of Treasury bills and notes. Even though the United States was the epicenter of the global crisis, investors viewed Treasury securities as the least dangerous place to park their money.

On top of that, the Fed used almost every tool in its arsenal to push interest rates down even further. It cut the overnight federal funds rate, the rate at which banks lend reserves to one another, to almost zero. And to reduce longer-term rates, it bought more than $1.5 trillion worth of Treasury bonds and government-guaranteed securities linked to mortgages.

Those conditions are already beginning to change. Global investors are shifting money into riskier investments like stocks and corporate bonds, and they have been pouring money into fast-growing countries like Brazil and China.

Articles in this series will examine the consequences of, and attempts to deal with, growing public and private debts.

The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month, and they have announced plans to stop buying mortgage-backed securities by the end of next March.
Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels.

The United States will not be the only government competing to refinance huge debt. Japan, Germany, Britain and other industrialized countries have even higher government debt loads, measured as a share of their gross domestic product, and they too borrowed heavily to combat the financial crisis and economic downturn. As the global economy recovers and businesses raise capital to finance their growth, all that new government debt is likely to put more upward pressure on interest rates.

Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury's average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education.

But that could seem like a relatively modest pinch. Alan Levenson, chief economist at T. Rowe Price, estimated that the Treasury's tab for debt service this year would have been $221 billion higher if it had faced the same interest rates as it did last year.

The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government's marketable debt — about $1.6 trillion — is coming due in the months ahead.

To lock in low interest rates in the years ahead, Treasury officials are trying to replace one-month and three-month bills with 10-year and 30-year Treasury securities. That strategy will save taxpayers money in the long run. But it pushes up costs drastically in the short run, because interest rates are higher for long-term debt.

Adding to the pressure, the Fed is set to begin reversing some of the policies it has been using to prop up the economy. Wall Street firms advising the Treasury recently estimated that the Fed's purchases of Treasury bonds and mortgage-backed securities pushed down long-term interest rates by about one-half of a percentage point. Removing that support could in itself add $40 billion to the government's annual tab for debt service.

This month, the Treasury Department's private-sector advisory committee on debt management warned of the risks ahead.

"Inflation, higher interest rate and rollover risk should be the primary concerns," declared the Treasury Borrowing Advisory Committee, a group of market experts that provide guidance to the government, on Nov. 4.

"Clever debt management strategy," the group said, "can't completely substitute for prudent fiscal policy."

President Abraham Lincoln Thanksgiving Address

Proclamation of Thanksgiving
By Abraham Lincoln, 16th President of the United States of America

The Year that is drawing to a close, has been filled with the blessings of fruitful fields and healthful skies. To these bounties, which are so constantly enjoyed that we are prone to forget the source from which they come, others have been added, which are so extraordinary a nature, that they cannot fail to penetrate and soften even the heart which is habitually insensible to the ever watchful providence of Almighty God.

In the midst of a civil war of unequaled magnitude and severity, which has sometimes seemed to foreign States to invite and to provoke the aggression, peace has been preserved with all nations, order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere except in the theater of military conflict; while that theater has been greatly contracted by the advancing armies and navies of the Union.

Needful diversion of wealth and strength from the fields of peaceful industry to the national defense, have not arrested the plough, the shuttle or the ship; the axe has enlarged the borders of our settlements, and the mines, as well of iron and coal as of the precious metals, have yielded even more abundantly than heretofore.

Population has steadily increased, notwithstanding the waste that has been made in the camp, the siege, and the battle-field; and the country, rejoicing in the consciousness of augmented strength and vigor, is permitted to expect continuance of years with large increase of freedom.
No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Most High God, who, while dealing with us in anger for our sins, hath nevertheless remembered mercy.

It has seemed to me fit and proper that they should be solemnly, reverently and gratefully acknowledged as with one heart and one voice by the whole American People.

I do therefore invite my fellow citizens in every part of the United States, and also those who are at sea and those who are sojourning in foreign lands, to set apart and observe the last Thursday of November next, as a day of Thanksgiving and Praise to our beneficent Father who dwelleth in the Heavens.

And I recommend to them that while offering up the ascription's justly due to Him for such singular deliverance's and blessings, they do also, with humble penitence for our national perverseness and disobedience, commend to His tender care all those who have become widows, orphans, mourners or sufferers in the lamentable civil strife in which we are unavoidably engaged, and fervently implore the interposition of the Almighty hand to heal the wounds of the nation, and to restore it as soon as may be consistent with the Divine purposes to the full enjoyment of peace, harmony, tranquility, and Union.

In testimony whereof, I have hereunto set my hand and caused the seal of the United States to be affixed.

Done at the City of Washington, this Third day of October, in the year of our Lord one thousand eight hundred and sixty-three, and of the Independence of the United States the Eighty-eighth.

By the President: Abraham Lincoln

Week's Summary

While I have tried not to be overly cynical on this blog, sometimes with the news that comes in, I can't help it. That's why I am posting this commentary from George Shipp. Sometimes his commentary is too cynical, even for me, but today I am finding it to be right along the lines of how I feel.

CHOICE Asset Management Commentary:
It was quite a week, chock full of news. The Dow Industrials reversed the prior week’s loss and climbed back above 10,000 with a 311-point gain, as our governmental authorities once again collectively said “whatever it takes.” (And whatever the consequences down the road, some would say) Before getting to economic and other details, consider these moves out of Washington, all coming in just a single week:

- By a rare 98-0 Senate vote, following similarly overwhelming 403-12 House passage, Congress is extending unemployment benefits, to provide at least another 14 weeks of relief for the jobless (20 weeks in states with 8.6% or higher unemployment).

- Buy a home before May 1, and you will receive at least $6,500 ($8,000 for first time buyers).
So far, 1.4 million have claimed the 1st-time benefit, at an overall cost of $10 billion. The new version expands the program to “move up” buyers, with a 50% increase in income ceilings for qualification ($225,000 for couples).

- H.R. 3548 also widens the time period businesses (like homebuilders) can claim losses, to offset previously booked income. That portion was deemed budget-neutral because large businesses paying foreign taxes will not receive a planned tax credit until 2018.

- And an additional employer payroll surtax of 0.2% helped fund the unemployment benefit. [Yeah, that'll be a good incentive to bring back jobs.]

- Fannie Mae reported an $18.9 billion quarterly loss, and asked for an additional $15 billion of taxpayer support.

- Fannie introduced a home “deed for lease” plan whereby, if you are facing foreclosure and cannot qualify for a mortgage modification (i.e. even after re-works and interest rate subsidies your income does not reach 31% of the new payment), you may be able to exchange your home ownership claim for a lease “at market rates” (which by definition will be lower). That’s right, taxpayers, you will be the lucky landlords who will assume responsibility for homes that have proven to be unaffordable, and you will rent them through a third-party management company to help out your neighbors who made those decisions.

- Fannie was going to sell $3 billion of tax credits to Goldman, Sachs and/or Berkshire Hathaway, but the Treasury ultimately nixed that as not in the taxpayers’ best interest.

- The FHA was unable to meet its deadline to issue an updated financial report. Its auditor said its computer models were “creating unexplained inconsistencies,” according to the New York Times.

- The House of Representatives passed a 1,994-page, $1.05 trillion Health Reform bill by a narrow 220-215 vote. Obviously, there is still a long road ahead before the plan becomes law. According to the (libertarian, i.e. small-government advocate) CATO Institute, the bill “would create 111 government agencies, boards, commissions and other bureaucracies -- all overseen by a new health-care czar bearing the Orwellian title ‘commissioner of health choices.’" About $730 billion of new taxes and fees would support the expansion. [There is just something majorly wrong with our political system if the majority are screaming they don't want this bill, but it passes anyway.]

From the “we don’t know whether to laugh or cry department,” following Administration assertions that the ARRA legislation (stimulus bill) had “saved” 640,249 jobs, many localities and reporters seemed to question the calculation, for example:

- The Associated Press reported that President Obama’s economic recovery program saved 935 jobs at the Southwest Georgia Community Action Council. “Trouble is, only 508 people work there.”

- The Milwaukee Journal Sentinel said that federal data indicated more than 10,000 jobs were saved or created in Wisconsin, but “that is rife with errors, double counting and inflated numbers based more on satisfying federal formulas than creating real jobs.”

- The Chicago Tribune reported that official counts of 473 teachers “saved” at the North Chicago Community Unit Schools District 187 could not be accurate, since the district only employs 290 teachers. “In the official report, Wilmette Public Schools District 39 was credited with 166 jobs saved by stimulus aid. Superintendent Raymond Lechner said the number should be zero. At Dolton-Riverdale School District 148, stimulus funds were said to have saved the equivalent of 382 full-time teaching jobs -- 142 more than the district actually has.”

- The Sacramento Bee said that the California State University system calculated it was able to retain 26,156 employees, equating to more than half its workforce and more than all “jobs saved” in Michigan, the highest unemployment state. But CSU spokeswoman Clara Potes-Fellow said “This is not really a real number of people.”

[Personally I was wondering how on the earth the government was going to measure their promise of "saving" jobs. I am not exactly sure why I wondered that when you can say just about anything with statistics; especially with statistics that are not based on any real data. Sounds like these were put together by the same statistics department that helped Pelosi with her statement of: "500 million Americans will lose their jobs" without the stimulus bill. According to her, that would occur every month without proper government action. However, according to the US census bureau, the current population of residents in the country stands at about 305,000,000. Ironically, her numbers would include her and the rest of the Senate, which I am all for.

The good news is that this also came in from another Economists commentary: "...The overriding message of last week's elections in the United States was that people are highly focused on the economy in general, and on unemployment in particular. As a result, politicians are becoming increasingly nervous about their re-election prospects. Notably, we would point out that current approval ratings for the US Congress are below the lows reached in 1994 and 2006 - the years marketing the two most recent major party takeovers of Congress." Personally I am focused on more than just unemployment, but I am happy that most others notice the poor job of representing the government is doing. Personally I don't think this definitely means there will be a party shift. I think it means we are headed for a more fundamental shift and both parties better make some changes.]

Great Ideas for Reform

It's articles like the following that make me wonder how much of this current 2,000 page bill were written by lobbyists. In other words; it seems to me that reform is not that complicated, unless you were trying to pander to specific groups.

I did remove some paragraphs from the article becuase they weren't relevant to my post.

The Whole Foods Alternative to ObamaCare
By John Mackey

“The problem with socialism is that eventually you run out of other people’s money.”
- Margaret Thatcher

With a projected $1.8 trillion dollar deficit for 2009, several trillions more in deficits projected over the next decade, and with both Medicare and Social Security entitlement spending about to ratchet up several notches over the next 15 years as Baby Boomers become eligible for both, we are rapidly running out of other people’s money. These deficits are simply not sustainable. They are either going to result in unprecedented new taxes and inflation, or they will bankrupt us.

While we clearly need health-care reform, the last thing out country needs is a massive new health-care entitlement that will create hundreds of billions of dollars of new unfunded deficits and move us much closer to a government takeover of our health-care system. Instead, we should be trying to achieve reforms by moving in the opposite direction – toward less government control and more individual empowerment. Here are eight reforms that would greatly lower the cost of health care for everyone:

1) Remove the legal obstacles that slow the creation of high-deductible health insurance plans and health savings accounts (HSAs). The combination of high-deductible health insurance and HSAs is one solution that could solve many of our health-care problems. For example, Whole Foods Market pays 100% of the premiums for all our tea members who work 30 hours or more per week (about 89% of all team members) for our high-deductible health insurance plan. We also provide up to $1,800 per year in additional health-care dollars through deposits into employees’ Personal Wellness Accounts to spend as they choose on their own health and wellness.

Money note spent in one year rolls over to the next and grows over time. Our team members therefore spend their own health-care dollars until the annual deductible is covered (about $2,500) and the insurance plan kicks in. This creates incentives to spend the first $2,500 more carefully. Our plan’s costs are much lower than typical health insurance, while providing a very high degree of worker satisfaction.

2) Equalize the tax laws so that employer-provided health insurance and individually owned health insurance have the same tax benefits. Now employer health insurance benefits are fully tax deductible, but individual health insurance is not. This is unfair.

3) Repeal all state laws which prevent insurance companies from competing across state lines. We should all have the legal right to purchase health insurance from any insurance company in any state and we should be able to use insurance wherever we live. Health insurance should be portable.

4) Repeal government mandates regarding what insurance companies must cover. These mandates have increased the cost of health insurance by billions of dollars. What is insured and what is not insured should be determined by individual customer preferences and not through special-interest lobbying.

5) Enact tort reform to end the ruinous lawsuits that force doctors to pay insurance costs of hundreds of thousands of dollars per year. These costs are passed back to us through much higher prices for health care.

6) Make costs transparent so that consumers understand what health-care treatments cost. How many people know the total costs of their last doctor’s visit and how that total breaks down? What other goods or services do we buy without knowing how much they will cost us?

7) Enact Medicare reform. We need to face up to the actuarial fact that Medicare is heading towards bankruptcy and enact reforms that create greater patient empowerment, choice and responsibility.

8) Finally revise tax forms to make it easier for individuals to make a voluntary, tax-deductible donation to help millions of people who have no insurance and aren’t covered by Medicare, Medicaid, or the State Children’s Health Insurance Program.

Rather than increase government spending and control, we need to address the root causes of poor health. This begins with the realization that every American adult is responsible for his or her own health.

Unfortunately many of our health-care problems are self-inflicted: two-thirds of Americans are now overweight and one-third are obese. Most of the diseases that kill us and account for about 70% of all health-care spending – heart disease, cancere, stroke, diabetes and obesity – are mostly preventable through proper diet, exercise, not smoking, minimal alcohol consumption and other healthy lifestyle choices.

Health-care reform is very important. Whatever reforms are enacted it is essential that they be financially responsible, and that we have the freedom to choose doctors and health-care services that best suit our own unique set of lifestyle choices. We are all responsible for our own lives and our own health. We should take that responsibility very seriously and use our freedom to make wise lifestyle choices that will protect our health. Doing so will enrich our lives and will help create a vibrant and sustainable American society.

Disappointing, but Not Surprising

I have not confirmed the below statements, but I did want to pass this along.

I know this isn't a popular statement amongst my fellow Republicans, but honestly I thought the Baucus plan was ok. It had some things I disagreed with, but for the most part it fit with what I thought would be a good compromise on health care reform that might work. That is until I started seeing the marginal tax arguments against it (which personally I don't understand why it changes things, but the evidence is there).

Anyway, how soon can we get rid of Speaker Pelosi?

CHOICE Asset Management Commentary from George Shipp:

The House released its health care reform bill on Thursday and it is a whopper, weighing in at 19
pounds and measuring nearly nine inches tall. The 1,990 page, 400,000-word printout is longer
than War & Peace. The plan is estimated to cost $894 billion over ten years ($2.24 million per
word, notes the Politico blog). The bill includes a government sponsored health plan, mandates
everyone to buy health insurance with a penalty equivalent to 2.5% of their modified adjusted
gross income or the average premium, whichever is less, removes the ability to use flexible
spending accounts or health savings accounts to purchase over-the-counter medicines with pretax dollars, and bans insurance companies from denying coverage to those with pre-existing
conditions.

Hopefully our elected representatives are fast readers, since Speaker of the House
Nancy Pelosi commented that a vote could come as early as this Thursday. Wouldn’t it be more
prudent to actually give people time to read and review the bill before cramming it through?

Here’s a link to the bill in case you’re up all night trying to finish off that leftover
Halloween candy and you need something to put you to sleep:

http://energycommerce.house.gov/Press_111/20090714/aahca.pdf

Too bad that if you do want to read it, it might be un-readable -- again thanks to Politico,
you will stumble across paragraphs like:

“(a) Outpatient Hospitals – (1) In General – Section 1833(t)(3)(C)(iv) of the
Social Security Act (42 U.S.C. 1395(t)(3)(C)(iv)) is amended – (A) in the first
sentence – (i) by inserting “(which is subject to the productivity adjustment
described in subclause (II) of such section)” after “1886(b)(3)(B)(iii); and (ii) by
inserting “(but not below 0)” after “reduced”; and (B) in the second sentence, by
inserting “and which is subject, beginning with 2010 to the productivity
adjustment described in section 1886(b)(3)(B)(iii)(II)”.


Me again. So, anyone think they can figure out that one paragraph's impact on our healthcare system would be before Thursday? How about this one along with the thousands of others? Better yet, how many of the primary supporters of this Bill have any clue as to what this paragraph says and then its impact on our healthcare system? And what on earth is the argument for getting rid of HSAs!!!!!!!

Response to a Bear

John Mauldin wrote a fantastic letter that I couldn't agree more with this week. He responds to a friend of his who is overall bearish on the future (and not just the economy). John's response fits with what I have been reading about the Fourth Turning and my own personal beliefs.

I highly recommend you not only read this, but share it with others. This is the hope that our nation needs now. Not blind hope built on desires for everything to turn out rosy, but the hope that comes with hard work and individual responsibility to make our own and combined future a happy one. Not a happy one because we didn't have trials and struggles and disagreements, but because we overcome them all for our greater good.

It's More Than Half Full
Ok, Bill, let's review those wonderful days from whence we sprang, so fraught with the advantages of having nothing. So potent with opportunity. It was the middle of the '70s when we started our careers. Inflation was high and rising. The Soviets were seen as a major threat. Japan was beating our brains out and buying everything, even if nailed down (like Pebble Beach and New York skyscrapers). I had to borrow money at 15% (or more) to buy paper in order to meet customer demands for printing. And guess what? The banks got into trouble and called loans willy-nilly. (My bank even called my mother and threatened her to pay off my loan - against written agreements - and she did. Evil -----------. The more things change... And that bank did fail, I report delightedly! Not that I hold a grudge.)

There were multiple successive and ever-deeper recessions. Gold was rising and the dollar was seen as a joke. Howard Ruff (a good friend to both of us when we were starting out!) and almost every newsletter writer were telling people to buy gold and freeze-dried food to protect themselves against a near-certain economic, if not apocalyptic, catastrophe. Unemployment was high and rising for a decade.

The correct answer to the question, "Where will the jobs come from?" back then was, "I don't know, but they will." And that is the correct answer today.

In 20 years, no one will want to come back to the halcyon days of 2005. Our kids (all 13 of them) are getting ready to live through what will be the most exciting period in human history. There will be a century's worth of change, measured by the standard of the 20th century, just in the next ten years, and then we will double that pace in the next ten after that. Medical miracles will mean our kids and grandkids will live a lot longer than their dads, although I intend to be writing well into my 80s, like our mutual hero Richard Russell.

There will be whole new industries developed in the US. How do I know that? Follow the money. The rest of the world spends a fraction of what we do on research and development. Where do you go if you are looking for venture capital?

Do I care if the Chinese and the "developing" world are far better off, relatively speaking, than the US in 20 years? Not a whit. Good on them. I hope they make discoveries and inventions and grow new businesses that benefit us all. But we are not going into some long dark night. We, and our kids, get to choose how we respond to what is the reality of the day.

Our nation had to almost hit the wall in 1980 before a Volker could come along and force us to take the pain of recession to beat back inflation. And we will have to come perilously close to the wall this time before we take action as a nation. Way too close for comfort. Maybe you are right, and we have a soft depression. I hope not; but even so, the world will be better, far better, in 20 years, with far more opportunities than today.

It was not fun starting new businesses in the '70s and early '80s. But we did. I remember coming to Baltimore and being (literally) afraid to get out of the car to visit your offices in the slums. But that was what you could afford. A far cry from the chateau in Ouzilly.

I lived in a small mobile home. Tiffani was born there, and we converted part of the kitchen to be her bedroom. (Yes, I was white "trailer trash.") But I got up every morning just like you did and killed as many alligators as I could. The rest had to wait 'til the next day.

And that is the legacy our kids have. They know what it is to wade into the swamp every morning. Never quitting. In thinking about this, you may be the father I respect the most. You have raised your kids to be multilingual children of the world. What a work ethic. How did you get them to scrape window shutters at your chateaus? (I actually saw this, and my kids marveled. Thereafter I threatened to make them go live with you when they didn't behave!)
You have given your kids the opportunity to follow their dreams, even demanded that they do so. And such dreams they (and mine) have. Will they succeed? Who knows? But they will go at it with gusto, in a world with more opportunities than you and I ever imagined 40 years ago. And, oh boy, were we optimists back then. How else could we have done what we did? If we believed the rhetoric that the world was coming to an end, would we have dared to venture out?

You cannot have raised your kids to be such bold adventurers without instilling in them a certain high level of optimism. I am going to out you, Mr. Bonner. You present yourself to your readers as a bona fide end-of-the-world pessimist. But you are a really and truly a closet optimist. Your whole business empire (and what an empire it has become!) is based on finding people who are optimists, in the sense that they think they can actually get people to send them money for what they write. Which they do! Even if it is to read why the world will come to an end, which thankfully it never does.

You are right in this: it is personal gumption that makes or breaks us. There are those who started out with less than we did (hard to imagine but true) and made a lot more. And there are those who started out with far more and made less. But there are very few who are happier than either of us. Or luckier.

Our kids? It is not the times that dictate the man (or daughter!), but the response of the man which dictates his own time. Today promises a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it.
And as our kids do just that, and as the millions of kids of those who read us do so, and the billions of kids who are just now getting ready to bust loose all work to achieve their dreams, the world is going to be a far more fantastic place. Smooth ride? Not a chance. We didn't get one; and in thinking through history, there have not been many smooth rides. Why should we think that will get any better? Our kids will just have to live with our generational (and individual) iniquities, government debt and all, and figure out how to master their own fates. But if I had a choice to take the '70s or today? In less than a heartbeat I would choose today. And I bet you would too!

Job Creation

I like these proposals to help bring jobs back. Unfortunately these will never be put into place because they put the responsibility on individuals and employers and those currently in power don't believe they are capable of making good decisions.

The union point (number 3) is a good one. I had an interesting conversation with someone who is currently a member of a union. It was interesting to talk to him about his situation because I happen to know a good amount concerning the macro level of his company. If the union gets its way, which is what this fellow wanted, they would literally ruin this company and defeat their own purposes of keeping their jobs. His standpoint is that because the company made deals with the union they had to stick to their agreements. I can see his point, and it is unfortunate that the economy has worked the way it has (and honestly this company has an outdated business model), but if the company is to survive it has to do what other companies have and cut the excessive costs (tighten the belt).

Steve Davis - Forbes Magazine:

1. Roll back costly benefit mandates for health insurance. The high cost of health insurance acts as a drag on job creation and wage growth. Benefit mandates set by the states prevent health insurance companies from offering inexpensive, no-frills plans. State-level mandates cover acupuncture, alcoholism treatments, chiropractors, fertility treatments, marriage counseling and much more--about 1,900 mandates across the 50 states. The effect is to limit choice among insurance plans, raise health insurance costs for employers and individuals and depress job creation. State governments should undo these harmful effects by repealing costly benefit mandates.

A bigger step is to eliminate barriers to interstate commerce in health insurance. Under current law, most employers cannot shop across state lines for health insurance. As a result, employers in states with onerous benefit mandates are stuck with high-cost health insurance. Barriers to interstate commerce limit choice, suppress competition and raise health insurance costs. One of the harmful consequences is to depress job creation.

Some argue that health care reform demands a comprehensive approach. However, there is no sound economic reason to delay proposals that would cultivate greater competition in the current system, expand choice for employers and workers, shrink labor costs and stimulate job creation.

2. Suspend federal minimum wage mandates. The current unemployment rate among American teenagers is nearly 26%. Minimum wage mandates are among the factors that drive teen unemployment rates to such high levels. These mandates raise the cost of labor for employers who would otherwise hire unskilled and inexperienced workers. As a result, employers substitute away from these workers and rely instead on capital-intensive production methods, skilled workers and self-service by customers. In this way, minimum wage laws undercut job opportunities for the least skilled and the least experienced. The effects are especially pernicious for the young, who are robbed of opportunities to land a job, acquire valuable training and experience, and demonstrate their worth to employers.

To help young and unskilled workers gain a toehold in the labor market, the federal government should suspend minimum wage mandates until unemployment returns to normal levels. Better yet, abolish the federal minimum wage. If these steps are too radical, then allow states to opt out of the federal minimum or set a lower state floor. States and localities already have the option to set a higher minimum and, unwisely, many have taken that path.

3. Renounce the grossly misnamed Employee Free Choice Act. This legislation, currently before Congress, threatens to stack the deck against employers in the union certification process. Current law requires a secret ballot election among workers when the employer opposes union certification. If the union wins majority support, the National Labor Relations Board certifies the union as the exclusive workplace representative in collective bargaining with the employer.

The Free Choice Act would eliminate the secret ballot requirement. Instead, union certification would require only that a majority of workers sign cards supplied by the union. This "card check" process is rife with potential for strong-arm tactics and intimidation by union supporters. Sign here or else!

It's unclear whether the Free Choice Act and card-check provision will become law. Fears that the act might become law are enough to chill investment by firms that could be targets of card-check union certification. To allay these fears and remove the chill from investment, President Obama and congressional leaders should forcefully renounce the act now. If they won't, moderate Democrats should step forward and publicly announce their opposition to the act. By taking this step, they would help restore business confidence and set the stage for more job-creating investments.

4. Experiment with how best to put the unemployed back to work and assess the results. Government agencies and community organizations have tried many programs to help the unemployed return to work. Some programs focus on job search assistance and interviewing skills. Others provide counseling about education and training opportunities. Yet others rely on re-employment bonuses for job losers or financial inducements to hire the unemployed. There is much potential to learn from these programs about which approaches are cost effective, and which are not.

Unfortunately, it's very hard to assess effectiveness unless programs are properly designed and implemented. Reliable evaluation requires careful measurement of program features, participant characteristics, local economic conditions and outcomes. It also requires the systematic use of treatment and control groups, as in testing regimes for new drugs and medical procedures. Each new unemployment assistance program that does not include a reliable evaluation regime is a wasted opportunity to learn about what works, and under what conditions.

There are several useful roles for the federal government here. One is to develop robust guidelines for evaluating programs that aid the unemployed. Another is technical assistance to governments or other organizations that seek to follow the guidelines. The federal government should also offer financial incentives to encourage experimentation and reliable program evaluation.

How should the government cover the cost of the financial incentives? Let the states re-channel a small portion of the funds for extended unemployment benefits into new programs for putting the unemployed back to work, provided that the new programs include a reliable method for program evaluation.

Experimentation and program evaluation won't solve the immediate jobs crisis, but they will help develop more powerful and cost-effective tools for putting the unemployed back to work in the future. Effective evaluations will also help identify ineffective programs that drain government coffers.

These four proposals will foster job creation and help reverse the downward slide in the labor market--and unlike the proposals attracting attention in Washington, they won't break the budget or raise tax burdens.

The Impossible Promise

Great article (at least this is a portion of it) by Hoisington investment Management Company:

The Impossible Promise

The federal government's promise to extricate the U.S. economy from this recession involves more spending (increasing public debt) and more subsidies for consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt. In previous letters we have discussed the fact that the government spending multiplier is zero (read Professor Robert Barro's book, Macroeconomics - a Modern Approach, p. 370). This means there is no long term income benefit from stimulus programs. According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009, "NBER Working Paper 15369") suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.

From a fiscal policy perspective the outlook for economic growth appears to be one of stagnation for several years due to the size of the federal debt, which is expected to rise 35.7% from 2008 levels to 76.5% of GDP over the next ten years according to the Office of Management and Budget (Chart 4). This exercise in government spending is, of course, an exact replica of the Japanese experience from 1989 to the present. Their debt to GDP ratios have gone from about 50% in 1988 to about 178% today, and yet their nominal GDP is no higher than it was 17 years ago, and their employment stands at twenty year ago levels. It is somewhat unsettling that as of the last employment report the United States employed 131 million people, a level that was first reached in 2000, which means the United States has had no net job gains for almost ten years.

Indeed, it appears that the fiscal chain around the free market neck is sufficiently onerous to restrain growth for several years. The promise of the government to revive growth through increased indebtedness is, indeed, an impossible promise.

Best Economic Article I've Read in a While

This is from John Mauldin, who is fast becoming my favorite analyst to read. Now don't avoid this article because of its length or because I said it had to do with the economy. It is a great general read. I'd be interested to hear comments from anyone who understands physics better than I do or chaos theory for that matter.

Fingers of Sustainability
"To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown - the first instinct is to eliminate these distressing states. First principle: any explanation is better than none...
The cause-creating drive is thus conditioned and excited by the feeling of fear ..." Friedrich Nietzsche

This weekend I turn 60 and have been a little more introspective than usual. I am often told that the letter I wrote well over three years ago on ubiquity and complexity theory and the future of the economy was the best letter I have ever done. I went back to read it, and it has aged well. I basically outlined how a financial crisis would unfold, and now it has.

On reflection, I think that there are perhaps other, even larger, events in our future than the recent credit crisis and recession; yet, just as in 2006, there is a great deal of complacency. But as we will see, there are fingers of instability building up that have the potential to create large disruptions, both positive and negative, in our future. And for the political junkies in the room, I offer a brief insight into what may be one of the more intriguing behind-the-scenes developments in recent years. Now, to the letter.

"Any explanation is better than none." - Nietzsche
And the simpler the explanation, it seems in the investment game, the better. "The markets went up because oil went down," we are told (except that when oil went up, then there was another reason for the movement of the markets). But we all intuitively know that things are far more complicated than that. However, as Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation.

"Ah," we tell ourselves, "I know why that happened." With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain that make us feel good. We become literally addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important in achieving the chemical release. And thus we look for reasons.

The credit crisis happened because of Greenspan's monetary policy. Or maybe it was a collective mania. Or any number of things. Just as the proverbial butterfly flapping its wings in the Amazon triggers a storm in Europe, maybe an investor in St. Louis triggered the credit crisis. Crazy? Maybe not. Today we will look at what complexity theory tells us about the reasons for earthquakes, tornados, and the movement of markets. Then we look at how the world and that investor in St. Louis are all tied together in a critical state. Of course, what state and how critical are the issues.

Ubiquity, Complexity Theory, and Sandpiles
We are going to start our explorations with excerpts from a very important book by Mark Buchanan, called Ubiquity: Why Catastrophes Happen. I HIGHLY recommend it to those of you who, like me, are trying to understand the complexity of the markets. Not directly about investing, although he touches on it, it is about chaos theory, complexity theory, and critical states. It is written in a manner any layman can understand. There are no equations, just easy-to-grasp, well-written stories and analogies.

As kids, we all had the fun of going to the beach and playing in the sand. Remember taking your plastic buckets and making sandpiles? Slowly pouring the sand into an ever bigger pile, until one side of the pile started an avalanche?

Imagine, Buchanan says, dropping one grain of sand after another onto a table. A pile soon develops. Eventually, just one grain starts an avalanche. Most of the time it is a small one, but sometimes it builds on itself and it seems like one whole side of the pile slides down to the bottom.

Well, in 1987 three physicists, named Per Bak, Chao Tang, and Kurt Weisenfeld, began to play the sandpile game in their lab at Brookhaven National Laboratory in New York. Now, actually piling up one grain of sand at a time is a slow process, so they wrote a computer program to do it. Not as much fun, but a whole lot faster. Not that they really cared about sandpiles. They were more interested in what are called nonequilibrium systems.

They learned some interesting things. What is the typical size of an avalanche? After a huge number of tests with millions of grains of sand, they found that there is no typical number. "Some involved a single grain; others, ten, a hundred or a thousand. Still others were pile-wide cataclysms involving millions that brought nearly the whole mountain down. At any time, literally anything, it seemed, might be just about to occur."

The piles were indeed completely chaotic in their unpredictability. Now, let's read this next paragraph from Buchanan slowly. It is important, as it creates a mental image that helps me understand the organization of the financial markets and the world economy. (emphasis mine)
"To find out why [such unpredictability] should show up in their sandpile game, Bak and colleagues next played a trick with their computer. Imagine peering down on the pile from above, and coloring it in according to its steepness. Where it is relatively flat and stable, color it green; where steep and, in avalanche terms, 'ready to go,' color it red. What do you see? They found that at the outset the pile looked mostly green, but that, as the pile grew, the green became infiltrated with ever more red. With more grains, the scattering of red danger spots grew until a dense skeleton of instability ran through the pile. Here then was a clue to its peculiar behavior: a grain falling on a red spot can, by domino-like action, cause sliding at other nearby red spots. If the red network was sparse, and all trouble spots were well isolated one from the other, then a single grain could have only limited repercussions. But when the red spots come to riddle the pile, the consequences of the next grain become fiendishly unpredictable. It might trigger only a few tumblings, or it might instead set off a cataclysmic chain reaction involving millions. The sandpile seemed to have configured itself into a hypersensitive and peculiarly unstable condition in which the next falling grain could trigger a response of any size whatsoever."

Something only a math nerd could love? Scientists refer to this as a critical state. The term critical state can mean the point at which water would go to ice or steam, or the moment that critical mass induces a nuclear reaction, etc. It is the point at which something triggers a change in the basic nature or character of the object or group. Thus, (and very casually for all you physicists) we refer to something being in a critical state (or use the term critical mass) when there is the opportunity for significant change.

"But to physicists, [the critical state] has always been seen as a kind of theoretical freak and sideshow, a devilishly unstable and unusual condition that arises only under the most exceptional circumstances [in highly controlled experiments]... In the sandpile game, however, a critical state seemed to arise naturally through the mindless sprinkling of grains."

Thus, they asked themselves, could this phenomenon show up elsewhere? In the earth's crust, triggering earthquakes, or as wholesale changes in an ecosystem - or as a stock market crash? "Could the special organization of the critical state explain why the world at large seems so susceptible to unpredictable upheavals?" Could it help us understand not just earthquakes, but why cartoons in a third-rate paper in Denmark could cause worldwide riots?

Buchanan concludes in his opening chapter, "There are many subtleties and twists in the story ... but the basic message, roughly speaking, is simple: The peculiar and exceptionally unstable organization of the critical state does indeed seem to be ubiquitous in our world. Researchers in the past few years have found its mathematical fingerprints in the workings of all the upheavals I've mentioned so far [earthquakes, eco-disasters, market crashes], as well as in the spreading of epidemics, the flaring of traffic jams, the patterns by which instructions trickle down from managers to workers in the office, and in many other things. At the heart of our story, then, lies the discovery that networks of things of all kinds - atoms, molecules, species, people, and even ideas - have a marked tendency to organize themselves along similar lines. On the basis of this insight, scientists are finally beginning to fathom what lies behind tumultuous events of all sorts, and to see patterns at work where they have never seen them before."

Now, let's think about this for a moment. Going back to the sandpile game, you find that as you double the number of grains of sand involved in an avalanche, the likelihood of an avalanche becomes 2.14 times more likely. We find something similar with earthquakes. In terms of energy, the data indicate that earthquakes become four times less likely each time you double the energy they release. Mathematicians refer to this as a "power law," a special mathematical pattern that stands out in contrast to the overall complexity of the earthquake process.
Fingers of Instability

So what happens in our game? "... after the pile evolves into a critical state, many grains rest just on the verge of tumbling, and these grains link up into 'fingers of instability' of all possible lengths. While many are short, others slice through the pile from one end to the other. So the chain reaction triggered by a single grain might lead to an avalanche of any size whatsoever, depending on whether that grain fell on a short, intermediate or long finger of instability."
Now, we come to a critical point in our discussion of the critical state. Again, read this with the markets in mind (again, emphasis mine):

"In this simplified setting of the sandpile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point. What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size."

Now, let's couple this idea with a few other concepts. First, Nobel laureate Hyman Minsky points out that stability leads to instability. The more comfortable we get with a given condition or trend, the longer it will persist and then, when the trend fails, the more dramatic the correction. The problem with long-term macroeconomic stability is that it tends to produce unstable financial arrangements. If we believe that tomorrow and next year will be the same as last week and last year, we are more willing to add debt or postpone savings in favor of current consumption. Thus, says Minsky, the longer the period of stability, the higher the potential risk for even greater instability when market participants must change their behavior. (And, three years later, we can now all see that truth. But it was not as obvious to a lot of people in 2006.)
Relating this to our sandpile, the longer that a critical state builds up in an economy, or in other words, the more "fingers of instability" that are allowed to develop a connection to other fingers of instability, the greater the potential for a serious "avalanche."

Or, maybe a series of smaller shocks lessens the long reach of the fingers of instability, giving a paradoxical rise to even more apparent stability. As the late Hunt Taylor wrote, in 2006:
"Let us start with what we know. First, these markets look nothing like anything I've ever encountered before. Their stunning complexity, the staggering number of tradable instruments and their interconnectedness, the light-speed at which information moves, the degree to which the movement of one instrument triggers nonlinear reactions along chains of related derivatives, and the requisite level of mathematics necessary to price them speak to the reality that we are now sailing in uncharted waters.

"... I've had 30-plus years of learning experiences in markets, all of which tell me that technology and telecommunications will not do away with human greed and ignorance. I think we will drive the car faster and faster until something bad happens. And I think it will come, like a comet, from that part of the night sky where we least expect it."

A second related concept is from game theory. The Nash equilibrium (named after John Nash) is a kind of optimal strategy for games involving two or more players, whereby the players reach an outcome to mutual advantage. If there is a set of strategies for a game with the property that no player can benefit by changing his strategy while (if) the other players keep their strategies unchanged, then that set of strategies and the corresponding payoffs constitute a Nash equilibrium.

A Stable Disequilibrium
So we ended up in a critical state of what Paul McCulley called a "stable disequilibrium." We have players of this game from all over the world tied inextricably together in a vast dance through investment, debt, derivatives, trade, globalization, international business, and finance. Each player works hard to maximize their own personal outcome and to reduce their exposure to "fingers of instability."

But the longer we go on, asserts Minsky, the more likely and violent an "avalanche" is. The more the fingers of instability can build. The more that state of stable disequilibrium can go critical on us.

Go back to 1997. Thailand began to experience trouble. The debt explosion in Asia began to unravel. Russia was defaulting on its bonds. Things on the periphery, small fingers of instability, began to impinge on fault lines in the major world economies. Something that had not been seen before happened: the historically sound and logical relationship between 29- and 30-year bonds broke down. Then country after country suddenly and inexplicably saw that relationship in their bonds begin to correlate, an unheard-of event. A diversified pool of debt was suddenly no longer diversified.

The fingers of instability reached into Long Term Capital Management and nearly brought the financial world to its knees.

So, where are the fingers of instability today? Where are the fault lines that could trigger another crisis? Are there any early warning signs? I see two possibilities, one positive and one negative.
Chad Starliper sent me the following graph. It shows the debt-to-GDP ratio for the US, adding in various levels of debt. For instance, the ratio of debt to GDP for all levels of government debt is 87%. But if you add household and business debt along with the GSE (government-sponsored enterprises) like Fannie and Freddie, the ratio rises to 331%. If you add in future benefits of Social Security and Medicare, the number becomes more like 1,000%.

The Obama administration tells us that the government deficit is going to be well over $1 trillion a year for at least ten years. And that does not take into account the outlier years in the 2020s when the really heavy lifting of Social Security and Medicare kicks in.

There is a truism that goes a little like, "If something can't happen, then it won't." Let me make a prediction. We won't have a trillion-dollar deficit in ten years. Why? Because it can't happen. The market will simply not allow it.

As I have written, we can run large deficits almost forever, as long as the deficits are less than nominal GDP. While it may not be the wise thing to do, it does not bring down the system.
But when you start adding to the deficit in amounts significantly larger than nominal GDP, there is a limit. Each dollar, like the grains of sand, adds to the potential instability of the system. Is it $2 trillion more? $3 trillion? No one can know, but the longer it goes, the worse the ensuing financial earthquake will be.

The current political class and their intentions are dangerously close to killing the golden goose. It is one thing to steal the eggs; it is an altogether different thing to kill the goose through ignorance of the consequences. And the size of the deficit, for as long as they plan to have it, will most assuredly kill the goose.

Just as I was writing in 2006 about the potential for a crisis, and yet the party went on for quite some time, I think the party can limp along now. But there will come a point when the party is over. Interest rates on the long end will rise precipitously, forcing mortgages up and making the deficit even worse. It will be an even worse crisis than the one we have just gone through. And there will be fewer options for policy makers, and none of them will be good or pleasant. And it will take most people unawares. They will see the current trend and project it into the future. And they will be hit hard.

Can we avoid this calamity? Yes, we can wrestle the US budget deficit back under some kind of control, close to nominal GDP or on a clear trajectory to get there within a reasonable time (say, a few years). As noted above, we can run deficits close to nominal GDP almost forever. But there is no political willpower to do that now. And so, the market will at some point force the hand of the political class. That investor in St. Louis, or China or (????) will decide not to buy government debt at such low rates. The avalanche will start. And everyone will be surprised at the ferocity of the crisis. Except you, gentle reader. You have been warned.

Let me re-emphasize that point. If we do not get our act together, the results could be truly serious. And it is not just the US. Japan, as I have written, unless it changes, will hit the wall in the next few years. There are some really sick actors in Europe. You are going to have to be far more nimble and prepared for this next crisis, should it arise, than you were for the last one. Over the next few months, I will be devoting some space to helping us think through how we do that.

3 Billion and Counting
And now for something a little more positive. From the beginning of the wireless revolution and the development of the internet, it was not until 2001 that we finally had one billion people connected. It only took another six years to add another billion. And sometime in 2011, somewhere in the world, we will add yet another billion. We are adding some 70,000 people a day, with smarter and cheaper computers, phones, and netbooks. By some estimates, there will be five billion connected to the network by 2015.

A study done in 2005 of 21 developing countries by Leonard Waverman of the London Business School "... showed that an extra 10 mobile phones per 100 people in a typical developing country leads to an additional 0.59% of growth in GDP per person." (Jump Point)
Think of each one of those additional connected people as a grain of sand. We have already seen a large surge in productivity from the internet and mobile phones. Farmers in India now know what the prices are for their products and don't have to take lowball offers from middlemen. Fishermen in Indonesia can call around and find where they can get the best price for their day's catch.

Tom Hayes argues in his book Jump Point that, because of the growing connectivity, rather large changes are coming to the way we organize our lives. It is a very interesting book and one that I will review in depth at some point.

But what Hayes calls the Jump Point is what I referred to as critical mass. "In mathematics it is called a 'jump discontinuity.' In engineering, this is known as a 'step phase change.' In climatology, it is called an 'abrupt delta.' I call it a Jump Point - a change in the environment, in this case the business environment, so startling that we have no choice but to regroup and rethink the future." (from the introduction)

Not all of the changes are benign. The potential for business and marketing models to be turned on their head is rather striking. I recommend the book to those who are thinking about the future. It is easy to read, provocative, and well written. You can get it at Amazon.com. I wrote this three years ago: "Today more than ever your portfolio should be targeting absolute return strategies. In a world with fingers of instability that may be connected in ways we have not seen in the past, caution is the order of the day. If we do see a slowing US economy later this year, the average complacent investor is not going to be happy as his diversified portfolio all seems to be going south at the same time."