John F. Kennedy's 1957 Pulitzer Prize winning book Profiles In Courage reflected on the courage of 8 US Senators who demonstrated a willingness to do the right thing as opposed to the politically expedient or popular thing. I wonder if Kennedy were writing the book today if he wouldn't want to at least consider including Ted Cruz in his short list of Senators who demonstrated courage and leadership by pushing back against the status quo.
There are many who see Cruz as acting irresponsibly. I am not one of those people though and I do see Cruz as doing all he can to challenge the status quo and using all the tools at his disposal to do so - a demonstration of courage and leadership that is sorely lacking in Congress today.
As I listen to the back and forth rhetoric on the consequence of attaching to the spending bill a provision to delay implementation or defund Obamacare all I hear is that the right approach to the matter is to first "not allow a government shutdown". My own view is that the House Republicans - apparently ignited by Cruz's leadership - are finally doing the right thing and that right thing has very little to do with a government shutdown or Obamacare.
What they are doing is exercising their right as a part of a "checks and balances" system of government. That is not a bad thing. That is after all why we have both a House and a Senate and why we have two parties. The idea was that no one group would be allowed to implement an agenda unimpeded. The issue isn't whether the Democratic Senate or the Republican House is right or wrong on the matter as neither is right. The issue is whether the system of "checks and balances" should or should not be employed.
The House Republicans are insistent on spending cuts. Are they wrong? I don't think so. The Senate Democrats are insistent on more fiscal stimulus to the economy based on ever increasing deficit spending. Are they wrong? Probably not - at least in the short term.
The truth is that a continuation of deficit spending at the current rate is unsustainable. That is as close to a fact as we can get in matters economic as pointed out by the Congressional Budget Office. This is also as close to a fact as we can get - a withdrawing of fiscal stimulus will have very detrimental consequences to the economy. That is also pointed out by the Congressional Budget Office.
The point is there is no right answer to this dilemma. I think the best analogy is to think of a person who is riddled with cancer. He has two choices. He can undergo a very uncomfortable treatment that may involve chemo and radiation or he can die. We are at a point with the economy where we have the same choice - we can undergo a very uncomfortable process of dealing with the problem which means we curb spending or we can continue with the status quo until we no longer can.
Nobody has a good solution to this problem in the short term. We have added more to the national debt in the last 6 or 7 years than all prior administrations going back to the beginning of our republic. What have we gotten in exchange for this massive increase in debt? Not much in relative terms. If we didn't have a number of government financed safety nets in place today we would be just as bad off today as we were in the Great Depression.
But that is not really the point. Our political leaders always tend to take the easy way out as there is a real desire to avoid economic catastrophes on their watch. Most of us know instinctively and intuitively that we can't continue to borrow and spend our way to economic health but most of us it seems would prefer that the status quo continue for as long as possible - just keep "kicking the can". The inconvenient truth is that the longer the cancer patient waits before accepting the discomfort that comes with the treatment the less chance he has of surviving.
Here is the argument that one Democrat made on CNN a few minutes ago. She used the following analogy. If you spent a lot of money on a kitchen remodel and didn't like the outcome would you burn down the house or make some changes to the kitchen.
Her point is that even if you don't like Obamacare you don't shut the whole government down to get your way. My own thinking goes like this - if you firmly believe that a continuation of the status quo regarding off the charts spending will end badly you use whatever tools you have at your disposal. Depending on your perspective and your understanding of the matter it could be the most responsible thing to do.
Let us understand - the world doesn't end if we shut the government down. At some point one side or the other will blink or even better - both parties will choose to drop their partisan stance and actually engage one another in a positive way. That doesn't mean they come up with a solution that avoids pain as no such solution exists. What it does mean - at least I hope it does - is that both sides recognize that political expediency for their own self interests needs to take a back seat to the issue of survival.
The problems by the way are not exclusive to government. The problem is one of basic human nature. We all tend to see things from our own self interest perspective which is usually short term in nature. Corporations will employee lobbyists to gain advantage even if they recognize intuitively that what is in their best interest on a personal level may not be in the best interest of the masses. Lobbyists for their part will do whatever they can to achieve the desired end of their employers - again as it serves their self interest. Congress for their part will do the same and succumb to the pressure of lobbyists for personal gain - either political or financial.
The same applies to voters who will vote for those they see as promoting their own self interests. The same applies to governmental regulatory agencies that figure out ways to spend the full amount of their budget allocations and lobby for more next year even if it isn't needed to carry out their original mandate. It is the nature of man that we do these things. We all tend to promote our own self interests to the detriment of the greater good.
I used a quote from John Dalberg Acton in a recent article that seems appropriate to the subject:
The danger is not that a particular class is unfit to govern. Every class is unfit to govern. The law of liberty tends to abolish the reign of race over race, of faith over faith, of class over class.
I followed that up with this statement:
I am in no way suggesting we assemble a vigilante lynch mob and go after our political leaders. After all, in my opinion they have succumbed to the same power induced delusions that most of us would probably fall prey to were we in their position.
I for one like what the Republican led House is doing and for reasons that have nothing to do with Obamacare. They are playing the hand they were dealt and they are using the only leverage they seem to have to shift the tide and redefine the playing field as it relates to deficit spending. In other words they - at least this time - seem to have the courage of their convictions and they are willing to accept the potential political fallout from their actions. This takes courage and is indeed a shift that we haven't seen for a long time.
More importantly it forces legislators to seriously engage one another and work to legitimately deal with the issue and not just kick the can. That is a good thing. I will say that I also understand the President's stance as well as Harry Reid's stance on the matter. I am not critical of the President, Reid or the House Republicans on this matter. They are all pursuing a course they see as right. On the other hand I am pleased that the House is following through with their own agenda as that is what a system of "checks and balances" is all about.
Are there solutions?
The truth is we want black and white solutions to our problems but no such solution exists. The effect of an action can't be viewed in isolation. For example if we engage in fiscal stimulus we are creating both good and bad consequences. The good is the impact it has on GDP. The bad is the impact it has on the debt and deficit. There is a trade off and that is unavoidable.
Fiscal stimulus can have an impact on jobs and not just in the US but on a global scale. Jobs mean paychecks and paychecks mean increased spending and increased spending means higher demand and higher demand means more jobs and so on. Since the US represents a huge part of the global economy a thriving US economy benefits other countries who export goods and services to the US.
The downside occurs when the economy doesn't respond to fiscal stimulus. In other words if corporate America decides to work in their own short term self interest - as they have done since the onset of the Great Recession - and continue to shrink payrolls they shift the burden of economic growth back onto the government. The end game is that all are impacted negatively over time.
The number of variables in the ultimate economic equation that delivers the desired answer are so numerous that we will never be able to get it right. That said, we should be able to get it less wrong and that should be our goal - at least in my opinion. And that won't happen unless our political and business leaders see the merit in thinking outside the box and taking on a longer term view.
The inconvenient truth is that corporate profits are dependent on a large consumer pool and a large consumer pool is dependent on corporate America employing people they may not need to meet current demand or in the alternative for the government to provide fiscal stimulus to take up the slack. Should corporate America be encouraged to hire people they don't need? Or maybe a better question is can they be made to recognize that they will - in the long run - be better off in doing so as eroding and undermining the aggregate purchasing power of the consumer will result in their own ultimate demise?
Perhaps what makes sense is a tax incentive to businesses that rewards them for taking on employees they may not need in the short term. I haven't done the math so I don't know how this all would work out but I suspect we could develop an equation that would work to incentivize corporate America to do more hiring. Perhaps it would be in the form of a progressive tax that punished those whose payroll costs were below a certain percentage of total sales and reward those whose payroll costs were at or above the defined threshold.
Such an arrangement would need to be approached as a win/win for all and that includes corporations who would - in the aggregate - benefit from an increased level of employed people who would enter the consumer pool and produce increased corporate sales in the aggregate. The government would increase their tax base and therefore less fiscal stimulus and less debt would be needed and the American people would benefit through a higher standard of living in the aggregate.
One could even envision a progressive tax on consumers tied to their level of consumption. The more they spent on goods and services up to a pre-determined threshold the lower their tax consequence. It would be a progressive tax in that those with low incomes would pay appreciably less tax than those with high incomes and those with high incomes would have the incentive to spend a higher percentage of their income and in so doing drive demand and therefore GDP. A kind of virtuous circle of spending that benefits all.
A consumption tax credit would be the opposite of a consumption tax or national sales tax that has been proposed by some. A consumption tax would punish the low income as a much higher percentage of their gross income is needed to provide basic necessities. A much more logical approach would be to incentivize consumers and businesses alike to do those things needed to reinvigorate the economy and that means hire more and spend more.
Again, I haven't done the math on these tax incentive ideas and therefore can't say with any degree of certainty that the numbers would actually work to generate a sufficient increase in the tax base and therefore a sufficient increase in tax revenues to offset the reduced tax rates. Maybe it wouldn't work but I suspect some arrangement that defined the objective and then offered sufficient incentive to tax payers could be formulated in a way that would work.
The point though is that the status quo is clearly not working and it is only through out of the box creative thinking that a better solution will surface. As a Keynesian I have no problem with fiscal stimulus as a stop gap measure and certainly no problem with deficit spending. In fact as the world's reserve currency nation we are literally required to operate at a deficit for reasons way to complex to delve into in this article but I also recognize that a vibrant economy can't be built on the back of fiscal stimulus and that is what we have attempted to do for decades and the truth is we have reached a point where the "Law of diminishing returns" has reached its apex and the risk of continuing this policy going forward is that we are likely to experience negative returns - not just diminishing returns.
At some point we must accept reality and reality in this case is simple - what we've been doing isn't working and it is time to accept that fact and change course. Anyone who clings to the idea that we are in a business as usual dynamic today is simply in denial.
Reading between the lines
As the theatrics continue it is easy enough to assume that the matter is purely political and that all concerned are being honest in the way they are communicating with the public. I never assume that to be the case. For instance I think there is ample empirical support for the fact that President Obama abandoned the Bernanke "wealth effect" strategy back in February when he met with Bernanke at the White House.
Shortly after that meeting Bernanke announced that he would not attend the Jackson Hole Summitt. Then in April Vice-president Joe Biden gave a speech on the need for a New World Order. Was that Joe Biden just being Joe Biden or can we assume that President Obama sent his messenger out to float the idea to see what reaction it might receive?
Then Obama met with the CEO's of the TBTF banks and gold dropped $200 in 2 trading sessions. It seems a bit naive to assume that the meeting with the CEO's didn't have something to do with that sell off. But if that isn't enough to convince you consider that the Justice Department has aggressively attacked JP Morgan with civil and criminal actions. JP Morgan has agreed to roughly $1 billion in fines for their role in the "London whale" fiasco and they are now negotiating with the Justice Department on what appears to be another $11 billion fine for their involvement in the mortgage credit fiasco.
Criminal actions and fines of close to $12 billion are not in the category of token slaps on the wrist. More importantly though is my thesis that JP Morgan has been the equity arm of the Fed's Open Market activity. The Fed is allowed to buy bonds but not equities and it is my position that the Fed conspired with JP Morgan to back stop equities.
That position of course is pure supposition but for those willing to look at the evidence it is hard to argue against the idea that someone - a really big player - has actively pushed against the natural tendency of the market to sell off in the face of negative data time and again. In late December of last year the Congress grappled with the "fiscal cliff" issue that dealt with tax hikes and spending cuts. Most believed the "fiscal cliff" would have a significant negative impact on the economy and they were right. But stocks took off like a rocket right in the face of the "fiscal cliff" - a counterintuitive move to say the least as we did go most of the way over the "fiscal cliff" with tax hikes and sequestration cuts.
Are we to assume that market manipulation wasn't in play in this situation? You are free to view this as you choose but I will also point out that the "bad is good" market response doesn't appear to be in play in recent weeks. My thesis - JP Morgan is no longer actively back stopping the markets. The reason - they have been put on notice by Obama that the "Bernanke put" has expired.
That brings me to the issue of the Fed Chairmanship. Most seem certain that the status quo as it relates to monetary policy will be in safe hands with Janet Yellen. But not so fast - Donald Kohn is the only candidate President Obama offered up for consideration. Larry Summers, Janet Yellin and Tim Geithner were in the running by assumption only and both Summers and Geithner withdrew leaving only Yellen and Kohn.
We all know that Yellen is in the Bernanke camp as far as monetary policy is concerned and we know that Obama was very dismissive of Bernanke in an interview with Charlie Rose a few months back. We also know that Obama is pushing hard against JP Morgan and we know that Bernanke saw the bank as an ally in their "wealth effect" agenda.
In an effort to connect the dots one should consider Donald Kohn's comments on macroprudential monetary policy. The best way to view macroprudential policy is to think of monetary policy in the context of the big picture. Kohn's remarks centered on the ideas floated by the IMF and the IMF's main thrust as it relates to monetary policy is the need for a non-sovereign reserve currency - apparently the IMF's own SDR. The subject is simply not understood by the media and certainly not discussed by the media.
More relevant to the discussion though is that Kohn is clearly in the camp that sees macroprudential policy as desirable and that suggests he is on board with Joe Biden on the need for a New World Order - at least as far as it relates to monetary policy. That doesn't bode well for stock investors expecting the QE bull market to continue.
What can we expect going forward?
I am sure I will be disparaged by my perma-bull readers but I think the game is over. The truth is the economy does matter and the economy isn't responding to massive stimulus - both fiscal and monetary. More importantly it seems to me that Donald Kohn will be the next Fed Chairman - not Janet Yellen and that means the QE bull could be over. It does make sense after all as it certainly never produced the promised results as it relates to the economy.
We are still in a secular bear market and we are at the top of the 13 year trading range with a lot of risk to the downside. In January I made a very bearish forecast suggesting we would re-visit the 2009 lows this year. At the time I never expected the Fed to push QE to the levels they did nor did I expect investors to be deceived by the impact of QE as it relates to its economic impacts.
I did anticipate the possibility of the debt ceiling and deficit serving as a catalyst that would send stock prices lower but I expected that to occur back in the 1st quarter - not the 4th quarter. That said, it occurs to me that the catalyst that starts the markets lower may still be the debt levels and the matter of the deficit.
At times I feel like the "boy who cried wolf" a few too many times but the truth is the wolf did eventually come.
Disclosure: I am long FAZ, UVXY, VXX.
Additional disclosure: I am also long SPY puts