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Deflation and the Realities of Current Economic Policy


November 26, 2009


Well, if taking on Paul Krugman was a challenge, today we are going to take on The Economist, and specifically, the article “Stemming the Tide” published in their November 21st issue currently on the newsstands. The article can be found at:


Now I love The Economist.  It is the only major news magazine that I still own, having tired of such globally important issues as Pitt and Jollie’s vacation to Europe, the kind of trash that one has to wade through in Time.  Fortunately, all of the major newspapers around the world are now on the web and between those and the blogs, most US magazines are now irrelevant. The Economist has your standard European liberal tilt, but their editors tend to print both sides of an issue and do not subscribe to the deliberate errors of omission that are the stock in trade at the politically correct editorial desk of The New York Times.


So along comes the staff of The Economist advising us on how to climb out of the mess that our noble financial leadership, (cheered on by Congress) has created over the past several years.  As I read through their solutions, all I could think was that some editor must have a courier service that delivers B.C. bud directly to their desks on a daily basis.


First of all, let’s remember three sets of data.  70-20-10 is the magic number, which composes the percentages of GNP generated by personal consumption healthcare and social outlays, with financial services and other non-direct funding at 20%, and sadly, manufacturing is at the tail of the party. Secondly, U-6 which is the closest figure to the real unemployment in the US is near 20%.  Finally, the stated goal of our credit easing “policy” is to bury the consumer in funny money so that consumer demand will increase, companies will hire, and the GNP will head back to a normal trajectory. (Whatever that is with the new normal.)


On the government spending, or revenue side of the equation, the first comment is that we are spending too much at 25% of the GNP by 2019 and that entitlements are too high.  As a passing comment, it is mentioned that 5% of the spending is on the debt, and that is projected to triple over the decade.  In the column to the right, there is a figure of $792 billion in incremental cost per 1% increase in interest rates.  Let’s assume that Bernanke can stabilize this monster at a 3% increase in average interest rates.  The interest rate cost alone effectively triples the projected deficit for 2014, and is hardly something one can pass over as we move on to the “elephants” in the room, namely entitlements.  Solutions?  None.


Now, let’s move on to the “straight-forward” entitlement of Social Security.  The answer, of course, is to raise eligibility from the 65 moving to 67 currently in place to age 70. There are two slight problems with this solution.  First, exactly what does one do with the 55 to 70 year olds currently unemployed?  Are they likely to be at the head of the line when and if unemployment starts trending downward, or are they likely to be replaced with a trainable, youthful and cheaper model, with potentially 40-50 years of productive capability ahead of them?  This older generation is the very specific group which has seen their 401Ks destroyed in the market debacle, and do not have the productive time left in their lives left to rebuild them.  Secondly, if the age discrimination laws were ever seriously enforced and the “old” were hired, the net result would be to increase relative unemployment at the youthful bottom of the career track, and we have 250,000 youths per month coming into the job stream.  This is a group that one does not want to seriously tee off if one wants a stable community.  Bottom line, a move to 70 would create a “donut hole” that would cost considerably more than the one in Medicare.  Solution?  Probably impossible without a European style social net for this age bracket.


In addition to rising the retirement age, the second part of The Economist’s solutions for Social Security is to make benefits tied to rises in prices, rather than wages.  Sounds good to me!  With hyperinflation right around the corner, one personally could make a bundle, except that I cannot think of anything that would more quickly bankrupt the country.  One might also have a small problem with the revenue side of that equation.  I can see the wild eyed enthusiasm for the more affluent paying into the system a very large amount of money (necessary today to keep it remotely solvent) while receiving a social security income based upon prices. Of course, if the law were changed so that all were taxed the same and then paid the same, the loss of income from the over-payees over the next several years would send the system into an actuarial tailspin.


The third suggestion is to link benefits to an inflation index with less upwards bias.  I am not sure that the Bureau of Labor Statistics could design a CPI with less upward bias than the one currently propounded.  There is not an economist in the country, and certainly not a consumer, that believes that the CPI index accurately reflects cost increases.  A mild counter-analysis can be found at, while my personal, back of the envelope calculation is that our family food costs have increased 30% since the beginning of the recession.  This is a recipe for simply impoverishing those that exist above food stamps eligibility and below a comfortable incremental pension plan.


Next, the discussion moves on to Medicaid, for which the federal government pays between 50 and 83%.  The Economist suggests switching to “block grants” which I suppose is a euphemism for caps, adjusted for inflation and population.  Also, the suggestion is made that they “wealthy” states pay most of the share.  Question – Which states would The Economist determine as wealthy?  Currently, 30 of the 50 states have budget deficits, totaling in excess of $68 billion.  The only “rich” state with a comfortable budget surplus is Texas with $11 billion.  California alone would swallow the budget surplus of all the remaining states still in the black.   So exactly where would this Medicaid saving come from?  By increasing the local state taxes for a higher share of Medicaid payments in addition o the amount of tax hikes that will be necessary to bring the States to their constitutionally mandated balanced budget?


Defense, highway and agriculture support could certainly be cut, but one might question whether these items should be cut since they are likely to provide incrementally much more real employment than most of the so-called fiscal stimulus program for 2008, which ended up paying the salaries of presently employed state workers, and forestalling the state’s need for more serious budget cuts. I also take a little issue with the $20 billion of earmarks, which The Economist dismisses as simply rearranging the overall budget.  The money may not be much in a $1.6 trillion deficit, but its elimination might assuage some of the public that Congress is a more serious group of folk, that the current one that plans to continue their partying with a 12% increase in spending contemplated for the 2010 budget.


Now, on to European styled untapped revenue streams:


  • Eliminate employer provided health care?  - Guaranteed to saddle Obamacare with many more claimants than currently projected, drive up government health care costs, place a drag on the only major employment generator, which are small business, and place a regressive tax on the poor.


  • Eliminate Mortgage Interest Deductions? – With one home in four currently under water having mortgages higher than home value, let’s see if we could drive than number to 40-50%!


  • Reinstate capital gains taxes on homes? -  We have an enormous overhang of unsold homes on the market, with projections of up to a decade to stabilize the housing markets and get construction crews back employed.  Let’s see, with capital gains taxes on what is left of value in homes, we could probably drag out the date of housing stabilization for two decades!


  • Unlimited deductions for saving? – Regressive tax number One. Despite the economic term for “saving” which indicates what economists describe is happening in the US, the reality is that were are simply not spending – because we don’t have it to spend. This tax deduction would be a bonanza for those at income levels with high discretionary income, but would not touch the majority of the public.


  • National Sales Tax? – About as regressive as they come, especially since those 30 states that are under water will be imposing new sales taxes on top of anything dreamed up by Congress.


  • How about a VAT? – Super regressive, since the tax is hidden in the price of all consumer goods, and therefore the consumer does not know what they are paying for. When we started this discussion, do you remember the 70% number?  Well, the idea of all this funny money was for the banks to lend it to businesses and consumers in order to get them to - what? Buy?  If so does it make sense to saddle them with a long list of regressive, consumer targeted new taxes?  That should certainly spur them onwards!


I like the idea of a Bi-Partisan Commission to redesign the tax codes (read “bail-out’) but having lived in this country for some 60+ years, I am willing to take on all bets that this will not happen in the remainder of my lifetime.  Secondly, and most important, this country cannot generate sufficient taxable income from any serious GNP growth plan to repay our debt.  With projections of debt in the order of $11 trillion in the next decade, not including contingent obligations and off balance sheet liabilities, I can only give The Economist editorial staff a “good field, no hit” commendation for this article.  It has, however, made me more aware of the staggering proportions of this problem. I can criticize, but I am painfully aware of the lack to good solutions out there.

Disclosure: Long GLD, TBT, FAZ, Gold Bullion








November 23, 2009


The B-5 Bonus Problem


Yesterday I received the November 21st Edition of The Economist, which has decided to feature several articles advising us on how to “fix” our deficit.  I can hardly wait to get into it, but it will be several days to comb through all their “suggestions” to our benighted Congress and Government Financial Leadership.  In the meantime, I have been engaged in a debate with a good friend over the $30 billion in bonuses the B-5 plan to give to their hard working and obviously deserving management.  The figure really bothers me, but my friend says that I am succumbing to “populist” fervor, and should remember that as CEO I was one them.  I readily admit that some 50% of my compensation was bonus related for many years, but turning a technically insolvent firm into one with triple the revenues and a comfortable profit over five years (with no FASB magically disappearing liabilities) was hard work and the stress level from time to time will probably cost me a few years from my lifespan. Therefore, when one starts throwing around enough money to feed one million families of our unemployed for one year, I would like to understand what we, as an economy, got for their efforts.  The people most likely to have that information, or who could obtain it, are Bernanke, Shapiro, and Geithner. So, for purposes of this transparency were hear so much about, here are the questions I would like to ask this trio:


  1. What percentage of the $30 billion was earned through risk-free bookkeeping entries such as borrowing $1 billion from the FED at .25% and investing it in other government paper, such as the ten year Treasury, with the objective of pocketing $30 million per year?


  1. What percentage of the $30 billion was earned through High Velocity Trading programs, which through an agreement with the NYSE allowed them prior knowledge of large trades about to hit the floor, and which gave them the nanoseconds of time to get in front of the buy and sell orders with shorts or long positions which were then sold instantaneously after the major trades?


  1. What percentage of the $30 billion arose from taking risk, such as in underwritings and providing loans to higher risk companies who with the capital were able to boost unemployment?


  1. What percentage of the $30 billion arose from loaning to other Main Street Banks in order to keep the FDIC wolves from their doors?


  1. Finally, although this is probably a minor component of   the bonuses, I am dying to know why the Treasury and the FED are so fiercely fighting the GATA lawsuit demanding an audit of the 8,133 tons of gold in the Federal Reserve, and whether any of this gold has been leased or borrowed by the B-5 for the purpose of manipulating gold prices on the worldwide marketplace.

November 22, 2009

What kind of an economy do we think we are living in?


I have just finished one of many articles going around on the financial blogs about the fact that we are in a recessionary and not in an inflationary period, and therefore the QE printing press money is nothing to be worried about.  After all, the latest CPI shows a .1% increase, so why worry?  Well, for one reason, this is not 1979 -1981, when Volker had virtual control over the credit markets in the United States.  Too much inflation, no problem!  Raise the prime to 20.5%, insure that mortgages rise to 18.5% and auto loans to 17.4% and you stop inflation in its tracks!  Apparently Bernanke and the FED think that this option is easily available to them if their easy money policies lead (as they will) directly to inflation.  I would argue, however, that their eye is on the wrong ball.  The difference today, some 30 years later, is that we are living in a globalized economy, and from that perspective, we already have a 17% rate of inflation in the last nine months, and the printing presses are still running full tilt.  While the US consumer is thinking local, both his customers and suppliers are global. The CPI index only measures US prices, while the value of the product being purchased and sold is measured in the world marketplace.  There is no perfect universal CPI, but the best we have is the $USD index, which demonstrates that the dollar has depreciated from 90 in March to 75 today, relative to a basket of other major currencies. The only reason the relative decline is not a lot worse is that the Chinese Renminbi is pegged to the dollar, much to their discomfort. Still not a believer?  Well, import prices were up .7% this last month.  How does that compare with a .1% increase in CPI with 70% of GNP governed by retail sales and services, with only 10% in domestic manufacturing?  And here we have Geithner and Bernanke petitioning the Chinese to unpeg their currency from the dollar and raise it to market rates.  Are they crazy?  We might end up, under those circumstances, with a 30% decline in the dollar index.  We would end up with great export prices, but with a three to one import to export ratio, we would be unable to afford virtually anything we depend upon from foreign markets.  With a stroke of a Chinese pen, our inflation rate could triple, our 10 year Treasury yield would do the same (The Economist indicates that  each 1% increase in interest rates would increase the deficit by $792 billion), our stock market would tank, and any of the vaporous dreams about our economy as now being “stabilized” would be dashed.




November 15,2009

Deflation and the Realities of Current Economic Policy


One can go to almost any quasi-government tome and view the explanation over and over again that the FED is simply replacing the money lost in the credit melt-down, and therefore is not creating inflation. The toxic assets on balance sheets are simply being replaced by Bernanke and his printing press, and sometime in the future we will have the right amount of money chasing the same volume of goods as back in 2007, so why worry?  If the printing press or his calculations overshoot and create inflation, then he will simply raise the interest rates for deposits in the FED, causing banks to reduce their lending to the investment community, reduce consumption and economic growth, and bring things back to “normal” i.e. 1-3% baseline or steady state inflation rate.  Hence, economic policy will triumph over the “mistakes” of the investment bankers with their creation and sale of toxic assets and everything will be fine, ---or in other words, “I am here from the government to help solve your problems.”


Being a fiscal conservative with a somewhat knee-jerk reaction that the government financial regulators seldom get anything right (with perhaps the one exception of Paul Volker success at the FED in shutting down inflation during the Carter years) the current policy and management leaves me with more questions than answers and a high level of uncertainty.  I certainly do not have the answers and despair of ever getting them from our “Transparent” and “Independent” FED, so I thought I would toss a few out on this web page.


  1. The toxic assets in the “bailed out” banks, former investment banks, and insurance companies have apparently disappeared due to the FED’s leaning on the FASB for more accommodative rules regarding their valuations.  Where has this paper disappeared to, when will the paper raise its ugly head again, and does anyone with investment dollars captured in all this paper care about returns?


  1. I can understand Bernanke’s interest in recapitalizing the banks in order to boost the credit markets and reignite economic growth in the country, but does allowing bankers to borrow money at .5% and invest it in Treasuries at 3.5% for their own account, recapitalize the banks or simply provide $30 billion in “bonuses” for non-risk taking “investments.”  Tightening up lending policies has the marvelous effect of making the banks appear more conservative, while giving them the excuse for holding the money in house to pay for risk free government investments and their high velocity trading programs. How exactly does this money get out into the economy, other than through individual bankers, with their multi-million bonuses, being able to hire more domestics?  .


  1. The stock market has exploded over the past six months with a very unnatural linear growth rate where one can determine the angle of growth with a protractor.  Double digit percentage declines in revenues and profits of listed companies are rewarded with upticks as long as some forecaster somewhere in the world had forecasted a slightly lower number.  Is this market floating on some ether of hope, or is there some rational reason for these valuations? How much of this market valuation has been caused by small main street investors preparing for retirement by buying into this enormous risk, and how much of the valuation has been caused by the 70% of NYSE volume arising from the high velocity trading programs of a half dozen Wall Street firms?  (Refer again to the Wall Street bonuses described above)


I am not sure there has been any time in history when there has been such a wealth differential between Wall Street and its government saviors, the FED and the Treasury, and Main Street with U-6 unemployment rates approaching 20%, fiscal deficits and impending tax burdens which are multiples of any in history, and with its local banks failing (or being forced into receivership by the FDIC) at numbers greater than during the depression. Thank God the government is here to help us with our problems.