Economy

by

The Problem with Jobs in America

Yesterday I went to Sam’s Club to pick up some groceries. One of the items I was purchasing was a case of wine. I buy the wine by the case to take advantage of the 10% case discount. Every time I buy a case I am amazed at the difficulty the cashier and her manager have with calculating a 10% discount. They bring out their smartphone, start up the calculator app, and scratch their head. Sometimes they resort to paper. I offer them the answer since this calculation is pretty easy to do in your head but they look at me with a blank stare. After several minutes of fiddling around they come up with the answer and ring up the case. I used to be amused with this small piece of drama but now I am annoyed.

The problem with jobs in America is that we have a lot of unemployed people with less skills, education, and common sense than those who are employed. How are we going to find a job for these people? I am very skeptical that President Obama’s Manufacturing Jobs Plan is the answer. His plan focuses on high tech manufacturing. I just do not see many of the unemployed ever running a CNC machine. We need a lot of low tech industry jobs that have a competitive advantage over our foreign competitors. We need entry level jobs and I don’t see that happening anytime soon.

The White House’s plan follows four general guidelines: Investing in American-made technologies; ending tax breaks for companies that ship jobs overseas; new partnerships to bring jobs back to America and encourage companies to hire in America; and opening global markets to American-made goods.

by

Consumer Credit Update

For those inquiring minds that like annual comparisons, consumer credit increased from $2,627.4 billions in 2011 to $2,778.2 billions in 2012. This is 5.7% increase. Almost of all of this increase came from non-revolving credit(auto loans). Non-revolving credit increased from $1,780.1 billions in 2011 to $1,928.4 billions in 2012. This is a 8.3% increase. The revolving credit(credit cards) had a 0.3% increase from 2011 to 2012.  This is good news for the auto industry and bad news for everyone else selling to the consumer.

The Federal Reserve likes to estimate annual rates using quarterly results. It is a different way to look at the same problem. Here is their statement.

Consumer credit increased at a seasonally adjusted annual rate of 6-1/2 percent during the fourth quarter. Revolving credit was little changed, while non-revolving credit increased at an annual rate of 9-1/2 percent. In December, consumer credit increased at an annual rate of 6-1/4 percent.

Consumer Credit – G.19

by

Cutting Oil Subsidies

Cutting “oil subsidies” is an interesting subject. Most of the time when you ask for details on how the proponents plan to cut oil subsidies they are talking about altering depreciation schedules. The reason the depreciation schedules were altered in the first place was to encourage companies to increase their capital investments. This altered depreciation schedule is available to all companies not just oil companies. Increased capital investments are good for the economy and what is good for the economy is typically good for incumbent politicians. That is why the changed the depreciation schedules. This time we are seeing a different tax slant. Here is a quote from Representative Ellison in the Huffington Post.

Last week, I said that if Congress has to make cuts, we should embrace the idea of ridding ourselves of wasteful giveaways to the fossil fuel industry. Here’s an idea. Let’s cut the Master Limited Partnership loophole and fossil fuel subsidies.

Some years ago I invested in a Master Limited Partnership based on the recommendation of my broker. It was involved with “mezzanine financing” for small companies and it was a much more profitable venture for my broker than it was for me. In hindsight it was another way for brokers to sell me stuff I would not normally buy. Since I am older and wiser now, I avoid Master Limited Partnerships. Recently my mother-in-law invested in a Master Limited Partnership on advice of her broker. When I looked at its return on investment it was a lousy investment, too. Her broker does not like me anymore. There are more reasons to dislike Master Limited Partnerships. If you fill out your own tax returns, tax accounting for Master Limited Partnerships is a pain in the butt. As a person who lived in the oil patch for 18 years, Master Limited Partnerships are just another way to separate doctors, dentists, and lawyers from their money.

Although I would celebrate the demise of Master Limited Partnerships, Representative Keith Ellison’s argument that Master Limited Partnerships should be closed because they use a tax loophole is silly. This is the same loophole used by any partnership or sole proprietorship in which the income gets transferred directly to the partner or owner’s tax return. I doubt he is planning to change these areas, too. The biggest problem for Representative Ellison is that it is hard to get a bigger slice of the tax revenue pie when you are dealing with investments that do not generate much revenue. Oil companies are not offering their prime properties in this market. The properties in Master Limited Partnerships are tough investments to sell to the public. I suspect most companies will opt out of trying to make a market for these lower quality properties. If Representative Ellison was arguing that Master Limited Partnerships are lousy investments and should be avoided for the reasons I mentioned above, I would fully agree with him. In this case he is just making a purely political statement and the chances our country would get additional tax revenue by eliminating Master Limited Partnerships is between slim to none.

by

Happiness is an Emergency Power System that Works!

TC10323R

Last year was a particularly difficult electric power year for us. In the last 13 years we probably had four outages that lasted more than 24 hours. It happened so infrequently we kept the generator in the back of the barn. Last year we had four 24+ hour outages. The big problem for us is that we get our water from a cistern. That means that we need electricity to pump water. Ten years ago we had a transfer switch installed so we could safely use a generator to power 6 circuits that included the pumps. It was a Generac transfer switch with a double throw switch for each circuit. During the third power outage I hooked up the generator and it immediately tripped the breaker on the generator. My wife decided it must be the generator since our generator was ten years old and went out and bought a new generator. With this new generator we keep it in a much more convenient location to the transfer panel. I can roll out the generator and hook it up to the transfer panel in about five minutes. On December 23rd we had our fourth 24+ hour power outage. I hooked up the new generator and the breaker tripped whenever I tried to turn on a circuit. A circuit providing power to the water was not functioning whether it was connected to the generator or the utility power. Now I knew that the Generac transfer switch had a serious problem. I performed some emergency wiring to get power back to the pump. Two days after Christmas our electrician came out and confirmed that we had a problem with the transfer switch and cleaned up my temporary wiring. Last Friday we finally got our new transfer switch installed. The electrician replaced the Generac unit with a GE Power Transfer switch and a new electrical sub panel. This a more industrial looking solution so I have a warm, fuzzy feeling that this solution will be more reliable. I stayed home on Friday to test the switch and verify that the circuits were working. It worked. I was curious about the price of the transfer switch. I found it at Home Depot and Lowes for $118. This looks like a cost competitive and more reliable solution compared to the Generac prewired solutions.

100 Amp 240-Volt Non-Fused Emergency Power Transfer Switch-TC10323R at The Home Depot.

by

What Bothers Me about the Latest GDP estimate

The thing that bothers me the most about the latest GDP estimate is not that it was negative although that was surprising. What bothers me is that our experts completely missed the reduction in government spending due to the winding down of the war in Afghanistan. I have read enough economic history books to say that increases in defense spending have been a reliable way of stimulating the overall economy. It worked in World War II in the 40s, Vietnam War in the late 60s, and Reagan years in the 80s. Defense spending had mixed results at stimulating the economy in the 90s with the first Iraq war and in the last decade with the wars in Iraq and Afghanistan. I think there is a very good case to argue that defense spending has historically a larger multiplier effect on GDP growth than all of the ideas to stimulate the economy in the last stimulus package. Even Paul Krugman argued on PBS that a fake alien threat was needed to stimulate the world economy. So how did our experts miss the downside of war buildups?

by

The Fiscal Cliff Deal: The Good, The Bad, and The Ugly

By a 257-167 vote the House passed the fiscal cliff deal on Tuesday. For our family the vote is a good since:

  1. Both my wife and I have mothers who are older than eighty and have estates greater than 1 million but less than 5 million.
  2. All of the other tax increases except for the resumption of normal Social Security taxes do not affect us.

The bad news is that we are reminded that even in the face of disaster, our politicians cannot vote for spending cuts. I guess we have to run the economy into the ditch to get meaningful spending cuts. After reviewing a lot of economic history, my best guess is that we have been on a down hills slide since 2000 due to our debt load. Historically the three most powerful macroeconomic stimuli that increases consumer spending have been increases in defense spending, tax cuts, and increased consumer debt. If we cannot over-stimulate the economy with all three of these at work like we had during the Bush years, we are doomed to plan B, spending cuts and debt reduction. The 2009 stimulus spending package is a grim reminder that this time it is not different. We probably went over the magic debt to GDP number that Reinhart and Rogoff  talk about in their book, This Time Is Different: Eight Centuries of Financial Folly in 2000 but it was obscured by the consumer spending tricks of the last decade.

Too bad that these consumer spending tricks no longer work. Now we are left with the ugly option.  We know from history that there is a good way and a bad way to balance the budget. As the editorial in the Wall Street Journal, The Right Way to Balance the Budget, pointed out, the " the typical unsuccessful consolidation consisted of 53% tax increases and 47% spending cuts" while the "typical successful fiscal consolidation consisted, on average, of 85% spending cuts." Here is a summary of the bill that passed. History predicts that this bill with its preference for tax increases over spending cuts will be unsuccessful at balancing the budget or improving the economy. Fixing the spending problem was left for another day.

The Senate early this morning passed H.R. 8 by a vote of 89-8 to avert the fiscal cliff.  The bill now moves to the House.  Highlights of the bill include:

  • Raise the marginal tax rate to 39.6% on income over $450,000 (joint) and $400,000 (single).
  • Raise the tax rate on dividends and long term capital gains to 20% on taxpayers with income over $450,000 (joint) and $400,000 (single).  The top rate would remain 15% for taxpayers with lower incomes.
  • Estate and gift tax:  $5 million exemption (inflation-adjusted) and 40% rate.
  • Permanent and retroactive patch for the AMT.
  • Return of the exemption and itemized deduction phase-outs on taxpayers with income over $300,000 (joint) and $250,000 (single).
  • One-year extension of 50% bonus depreciation.
  • Extension of various tax extenders.

Revenue estimates from the Congressional Budget Office and Joint Committee on Taxation score the bill as adding $3.9 billion to the deficit over ten years compared to existing (January 1, 2013) law.  The White House has released this fact sheet and statement from President Obama.

TaxProf Blog: CBO on Fiscal Cliff Deal: $1 in Spending Cuts ($15 Billion) for Every $41 in Tax Increases ($620 Billion)

by

Switzerland’s “Debt Brake” Is a Role Model for Spending Control and Fiscal Restraint « International Liberty

I agree with Dan Mitchell on many issues. I just found this piece he wrote about Switzerland’s “Debt Brake” in April of 2012. I originally read about the “Debt Brake” in his opinion editorial in the Wall Street Journal. As Dan mentions it is not really a debt brake but a spending restraint and it is only as good as our legislators are willing to let it work. Although it is unlikely that this type of spending restraint will be part of the fiscal cliff negotiations Part I, it make be part of the Part II or Part III negotiations. Ultimately our politicians would have to embrace the fact that our major entitlement programs, Social Security, Medicare, and Medicaid, have become “pay as you go” programs. Here is his chart that shows the problem with spending growing faster than the tax revenues or population.

Obviously spending growth is a fundamental economic problem for the United States and our legislators are willing to copy good ideas from other countries. Representative Brady with his MAP act and Senator Corker with his CAP Act  think a similar debt brake policy in the United States would be a good solution to control the growth of federal spending. Here is what Dan said about the “Debt Brake”.

Switzerland’s debt brake limits spending growth to average revenue increases over a multiyear period (as calculated by the Swiss Federal Department of Finance). This feature appeals to Keynesians, who like deficit spending when the economy stumbles and tax revenues dip. But it appeals to proponents of good fiscal policy, because politicians aren’t able to boost spending when the economy is doing well and the Treasury is flush with cash. Equally important, it is very difficult for politicians to increase the spending cap by raising taxes. Maximum rates for most national taxes in Switzerland are constitutionally set (such as by an 11.5% income tax, an 8% value-added tax and an 8.5% corporate tax). The rates can only be changed by a double-majority referendum, which means a majority of voters in a majority of cantons would have to agree.

He goes on to make the point that this policy becomes a de facto spending cap and that it has been a good policy for avoiding the fiscal crisis problems affecting the rest of Europe.

Switzerland’s spending cap has helped the country avoid the fiscal crisis affecting so many other European nations. Annual central government spending today is less than 20% of gross domestic product, and total spending by all levels of government is about 34% of GDP. That’s a decline from 36% when the debt brake took effect. This may not sound impressive, but it’s remarkable considering how the burden of government has jumped in most other developed nations. In the U.S., total government spending has jumped to 41% of GDP from 36% during the same time period.

He concludes with:

To conclude, we know the right policy. It is spending restraint. We also know a policy that will achieve spending restraint. A binding spending cap. The problem, as I note in my oped, is that “politicians don’t want any type of constraint on their ability to buy votes with other people’s money.”

Overcoming that obstacle is the real challenge.

Switzerland’s “Debt Brake” Is a Role Model for Spending Control and Fiscal Restraint « International Liberty

by

The Problem with the Economy is People Like Me

Since we are all Keynesian economists until we realize that “Keynesian economics” doesn’t work, the problem with the economy is the lack of consumer demand. So let’s do the math on consumer demand. The 47% dependent on the government for their income are by definition living from paycheck to paycheck and have a very limited chance of expanding their spending. The remaining 53% are in a different pickle. Most of those businesses have not seen their sales grow. As a result their employees have not seen their wages grow. In this group are some consumers saddled with too much debt. Since they seeing the increased costs of living, their budget for the upcoming year is to spend less and try to work their way down to a more manageable debt load. I don’t put a lot of hope that they will increase their spending.  They could opt to default on their loans but this will not allow them to increase their spending. There is a part of 53% that had their houses foreclosed on or they defaulted on their consumer debt. If the financial system still has any common sense then these people credit score is bad enough to keep them from spending more than their income for many years to come. From 1980 to today this economy has lived off of convincing consumers to increase their debt. Now there is a much smaller group of consumers who can afford to spend and increase their debt then there was in 1980.

So now we get to people like me who can afford to spend or increase their debt but choose not to. Like most people who feel blessed to have a job and to be debt free, I do not feel wealthy. I still have financial problems. It is highly likely that my income will not go up in 2013 and  I already know that my health care, taxes, and utilities are all going up in 2013. I feel a quiet desperation with my future. My time is running out to save money for retirement. It is critical that I increase my retirement saving rate but my health insurance costs are are accelerating even though we are a healthy family. It is frustrating that in this current health care system a significant portion of my health care cost increase is going to pay my “fair share” to help the uninsured pay for their insurance. Unfortunately this diverts funds I was planning to use for my retirement.  If the system is not working for those with a job, no debt, and good health, the system is not working for anybody. So I am going to focus on doing the simple things to take care of my family. I will cut back on smartphone and cable TV costs. A new car or a house is out of the question. If we are lucky we will not buy any new appliances either. Going without health insurance is an option. Although John Maynard Keynes is cursing me from his grave to spend more for the good of the economy, the economy will have to fix itself without me. Good luck to those Keynesian economists trying to stimulate consumer demand!

by

No Pain, No Gain!

I think it was Reinhart and Rogoff who advocated in This Time Is Different: Eight Centuries of Financial Folly that if we want to fix the United States economic problems we need about $7 of “real” spending cuts to $1 of increased tax revenue through structural tax reform. Yea, it has to be real spending cuts and meaningful tax reforms.  Europe has chosen the no pain approach and chosen policies that are light on spending cuts and heavy on tax increases. This is not a ratio that has succeeded in the past so it is not surprising that Europe’s economy has slowed down and the tax revenue situation is much worse. So we can reform our economic policies now or we can do it later with a much weaker economy. I guess it is too much to hope that we can be a little bit smarter about policies that work to fix our economy than Europe.

Of the supposed savings, then, $1.6 trillion comes from tax hikes and $577 billion comes from spending cuts, not counting saved interest. So 73% of the savings comes from taxes, 27% from spending cuts. That’s $3 of tax hikes for every $1 of spending cuts.

Even if you include interest savings, 60% of the debt reduction comes from tax hikes. Obama is making the exact mistake Europe is making by employing a tax-hike heavy version of fiscal austerity. Indeed, a 2010 analysis by AEI scholars found that successful fiscal consolidations are heavy on spending cuts, light on tax hikes. Even Bill Clinton’s debt reduction plan was 2-1 in favor of spending cuts. The Obama plan is dangerously unbalanced, especially given the weak economic recovery.

European-style austerity: Obama’s new ”˜balanced’ debt plan is 73% tax hikes
James Pethokoukis
Wed, 14 Nov 2012 15:57:11 GMT

by

Cliff Notes on The Age of Deleveraging by A. Gary Shilling

I just finished reading The Age of Deleveraging by A. Gary Shilling and I agree with his analysis and conclusions. I think that his book is the most important book on economics that I have read this year so I included some notes from the book for my future reference. Part of the reason I enthusiastically agree with his analysis is because it matches my own analysis. Over several posts I have been looking for signs that the consumer is actually deleveraging. Part of my curiosity stems from listening to Dave Ramsey try to convince people of the benefits of becoming debt free and wondering whether he is part of a larger trend. The other part is trying to figure out what the average American will do with their investments and disposable income in a slow growth environment. Mr. Shilling and I come up with the same conclusion. It is time for the American households to unwind the excess borrowing on credit cards and student loans that occurred over the last thirty years. Consumer spending as a driver for the economic growth is tapped out.

In a similar way I was fascinated with the problems that CALPERS and other pension plans are facing if our economy fails to grow at 4% per year. It seems many of the pensions plans are making big bets that the economy will grow at 4% and the stock market returns will grow much faster than that. The reality is that CALPERS recently announced that their 1-year return was 1%, their 10-year return was 5.7%, and they are spending about 6.4% of their portfolio on benefits. For kicks I charted the inflation adjusted returns for the GDP(blue line), S&P 500(red line), and our total debt(green line). From the chart you can see a pretty good correlation between the three indices from 1980 until 2000. For that time period I came to the conclusion that the growth in debt from was primarily responsible for the growth in the economy and the stock market. Traditional economic theory seems to be working. After 2000 the correlation falls apart. It is as if we passed a tipping point and the equation we use to describe the economy changed. Increased debt was no longer a good thing for the economy or the stock market. Debt soared but the economy hardly budged off of its long term trend line and stock prices went down on an inflation adjusted basis. For pension plans like CALPERS that really sucks! For those who think we can borrow our way to economic growth, you need a new plan. I was pleasantly surprised the Mr. Shilling noticed the same problem with inflation adjusted stock returns and debt.

Here are my cliff notes from the book and two posts about the book at BusinessInsider.

Slow Growth Ahead

Global slow growth in the next decade will result from the U. S. consumer retrenchment, financial deleveraging, increased government regulation and involvement in major economies, low commodity prices and the shift by advanced lands to fiscal restraint.

No Help from Anywhere

Four more reasons for slow global growth: Rising protectionism, continuing U. S. housing weakness, deflation and weak state and local government spending.

Chronic Worldwide Deflation

Deflation comes in several varieties, but is fundamentally driven by supply exceeding demand. Productivity-saturated new tech and globalization will drive the good deflation of excess supply while slow economic growth introduces the bad deflation of deficient demand. As the combine, I look for chronic price declines of 2 to 3 percent annually.

Twelve Investments to Sell or Avoid

#1 Big-ticket consumer purchases

Consumer discretionary spending is getting whacked as Americans grow debt shy. Moreover, consumers will have less money to spend.

Autos, appliances, airlines, cruise lines and leisure and hospitality providers will suffer.

#2 Consumer lenders

America could be finally, finally kicking the credit habit. Credit card companies, like Visa (V), and various financial firms will pay the price.

#3 Conventional home builders

Home prices are dropping (Shilling predicts a 20% drop). People are losing interest in giant McMansions. Add to that America’s newfound antipathy toward debt and you’ve got a bear market for home builders.

You might want to avoid PulteGroup (PHM), Beazer Homes (BZH), M/I Homes (MHO), Ryland Group (RYL) and KB Home (KBH).

#4 Collectibles

Collectibles are another casualty of deflation. That Rembrandt could be worth less in a few years.

#5 Banks

Home prices aren’t done crashing. When they do, banks will suffer from a wave of foreclosures. The financial system will be revived after the crisis with new profit-crushing regulations.

Mortgage heavyweight Bank of America faces the biggest liability.

Shilling also names Goldman Sachs as a potential target for CDO suits.

#6 Junk securities

Shilling calls this year’s rally in junk bonds overblown. Slow revenue and cash flow growth will make it impossible for many firms to service debts.

#7 Flailing companies

Companies with below-average revenue growth and high fixed costs and debt will be the first to drop in the coming era.

Shilling does not give any examples. We’re going with US Steel.

#8 Low tech equipment producers

US industrial production has stalled and won’t need many machine tools and parts. Besides, these products are made a lot cheaper abroad.

#9 Commercial real estate

Demand isn’t increasing as the US economy stalls. Moreover, loans made in the bubble come due in 2012, threatening a wave of foreclosures that will crater demand.

#10 Commodities

Slow global growth means there won’t be much supply pressure for oil and other commodities. Meanwhile, deflation will bring down prices.

#11 Chinese and other developing country stock and bonds

Emerging markets aren’t there yet, Shilling says, and won’t be able to pick up the slack from a languishing U.S. For overheating markets like China, this will lead to a sudden crash.

#12 Japanese securities

Shilling predicted the Japanese crash in 1988, and he says the slow-motion train wreck isn’t over yet. Bad demographics and lack of export growth are just now making their pretense felt.

Ten Investments to Buy

#1 Treasury bonds

Shilling says he has been a 30-year Treasury bull since 1981. The "bond rally of a lifetime" is going to continue as deleveraging causes deflation. Even Ben Bernanke won’t be able to stop that.

#2 Dividend payers

There won’t be much growth, so you might as well collect dividends. A few examples include Procter and Gamble (PG), Unilever (UN), Coca Cola (KO) and PepsiCo (PEP).

#3 Consumer staples

Consumer discretionary spending is getting whacked, but people still need to buy bread and socks. Stores like Walmart are well-positioned to grow.

#4 Small luxuries

People want to spend money on something. Shilling says items like snakeskin tote bags, five-blade razors and designer jeans could be the new type of conspicuous consumption, taking the place of big ticket items like sports cars.

#5 The dollar

With Europe and Japan drowning in debt and emerging markets verging on a crash, the dollar is going to start looking pretty good. Shilling says the dollar will remain the world’s currency, with no real competition from gold or the yuan.

Meanwhile, America will be mired in deflation.

#6 Investment managers and financial planners

Low investment returns will discourage day-traders and encourage the use of professionals.

#7 Factory-built houses and rental apartments

Cheap small homes are the order of the day, as old people look for a cheap retirement spot and young people look for a small mortgage.

Renting will be a more and more popular strategy.

#8 Health care companies

As America ages, the health care industry seems unstoppable. Even Obama’s health care reform ended up boosting earnings for many companies.

#9 Productivity enhancers

Anything that helps juice bottom lines will do well in the new era. This includes consulting groups, computers, internet, biotech and telecom.

#10 North American energy

Shilling is bullish on deepwater drilling and natural gas, as well as coal and nuclear. He has particularly high hopes for the massive Canadian oil sands.