Category Archives: markets

Monetary Policy

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This week’s print version of Der Spiegel has a cover depicting a slowly melting €1 coin captioned Vorsicht, Inflation! Die schleichende Enteignung der Deutschen, or roughly, “Caution, inflation! The creeping expropriation of Germans.”  Inflation erodes the value of (German) wealth.  An English translation of an article summarizing this cover theme can be found here.

Andrew Bosworth, chief portfolio manager for PIMCO in Germany (PIMCO is a global investment management firm of serious proportion), describes the underlying problem:

The industrialized world is stuck in a severe debt and growth crisis.  The central banks are fighting the disease with monetary infusions of previously unknown proportions[.]

Then he notes the problem this “cure” is generating:

[T]he side effect is a slow but dangerous devaluation of money.

And

Gradual inflation has a numbing effect.  It impoverishes the lower and middle class, but they don’t notice[.]

Indeed, paraphrases Spiegel Online,

For the past five years, governments from Berlin to London and from Brussels to Washington have been in crisis mode.  They rescued the banks in 2007 and 2008, then they stimulated the economy and, since 2010, have threatened to drown in their own debts.  The burdens are being pushed up the line, from private investors to central banks and government bailout funds.  But this doesn’t make the debts any smaller.

Despite this, though,

[T]he central banks of the United States, the euro zone, Great Britain and Japan jointly announced their intention to pump even more cheap money into the financial markets…. [The banks and the populations, both] recognize that governments seem to be willing to accept higher inflation if it facilitates debt reduction.

Especially since inflation, devaluing the relevant currencies, devalues the debts measured in those currencies.

What has a German portfolio manager to do with our situation in the US?  The inflation threat from throwing money at the problems of an economic dislocation is a basic principle of economics; it’s not unique to Germany.  Banks aren’t lending, or borrowers aren’t borrowing: throw money at the banks.  Folks aren’t spending because…pick a reason: throw money at the banks.  There’s too little economic activity, generally, because…pick a reason: throw (“stimulus”) money at the economy.  Whatever the mechanism, the response (I do not say “answer”) has been to increase the money supply.

But the outcome, whatever the path, is an enormous increase in the amount of money chasing a supply of goods and services that is not increasing at all in a stagnant economy, or one that’s growing more slowly than the population.  Or, at present, isn’t chasing at all because the recipients of all that money are sitting on it in some way: banks are chary of lending because, for instance, they’ll get hammered by our government for making bad loans, even as they’re currently yelled at by our government for not lending.  Citizens aren’t spending, preferring instead to pay down current debt or to save, husbanding their small wealth against a too uncertain future.  This is the textbook condition for enormous inflation when the dam breaks.

What are the Fed and the Obama administration doing in the US?  Throwing money at the banks (the Fed’s artificially suppressed—to essentially zero—interest rates and QE1, QE2, QE3,…,QE∞(?)) and the administration’s throwing money at our economy (stimulus “investing” nearly annually since winter 2009, sweetheart loans, and loan guarantees).

We have an increasingly vast supply of money chasing a supply of goods and services that is not expanding.

As I mentioned at the top, when inflation does strike, it will hit the poor and middle-income folks much harder than the wealthy: the former already spend the vast majority of their wealth on the necessities of life: food, fuel, clothing, and shelter.  Yes, more personal financial discipline would help—and folks should be exercising this discipline as a matter of course.  They are, too: the trend in savings rates, especially relative to income rates, has been to increase savings since the Panic of 2008 struck.  But the coming inflation explosion can easily overwhelm those efforts.

Heads up.

Solar and Wind Energy Subsidies

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There was sort of a debate presented in The Wall Street Journal a few days ago concerning the efficacy of Federal subsidies for solar and wind energy companies.  I say “sort of” because the Mark Muro’s arguments in favor of the subsidies demonstrate an utter cluelessness of the basics of economics as well as of how well the subsidies have already performed.

For instance, the WSJ‘s lede cites generic proponents as saying in all seriousness,

There is widespread agreement that pulling the plug on the subsidy at this point could hobble the wind-power industry.  Meanwhile, the biggest federal subsidy for solar power, a tax credit for 30% of the cost of installed equipment, is set to drop to 10% at the end of 2016.  A cash grant for up to 30% of solar equipment costs expired at the end of last year.

Proponents say wind and solar subsidies are needed for a few more years to allow these clean, renewable sources of energy to develop to the point where they can compete on price with electricity produced from coal and natural gas.

Yet, if the technology can’t compete in a free market on its own, if it needs the subsidy to survive, the technology is not ready for commercial use or sale.  Spending taxpayer money—private citizen money—on such a thing is a textbook example of Fraud, Waste, and Abuse.  As the proponents admit without realizing it in that second paragraph: “…wind and solar subsidies are needed for a few more years to allow these clean, renewable sources of energy to develop….”

Muro then says in his argument,

Let’s remember the point of these temporary subsidies: to help emerging clean-energy technologies gain toeholds in challenging markets and advance toward unsubsidized price-competitiveness.

And

The ultimate reward is cheaper, cleaner energy and greater energy diversity, which will help guard against price shocks, keep energy costs down through competition and lessen the damage our energy consumption does to the environment….

Except that it isn’t cheaper if it needs subsidies coupled with coal, oil, gas (hydrocarbon) prices that are artificially elevated by government mandates to include “green” additives as the Feds do, or to buy electric power from solar and wind generators, as California does, in order to compete.  Moreover, diversity is reduced, not expanded by limiting us to solar and wind—or even by demanding that we buy a certain amount of solar and wind, regardless of market forces—and actively blocking access to hydrocarbon energy.  And finally, if these really are viable technologies that will deliver cheap energy easily, private investors will flock to invest, and no taxpayer subsidy will be even in the picture.

On top of that, there’s no case for environmental “damage,” given the great amount of cleanup already done, and the falsified “damage” attributed, for instance, to fracking by the EPA.

Muro goes on:

Wind and solar need the help because the barriers for new technologies in the energy industry are tougher than those in any other industry in this country.  Fossil fuels, with the help of their own government subsidies over the years, are thoroughly entrenched, with trillions of dollars’ worth of infrastructure in place.

Never mind that that entrenched infrastructure sits on top of centuries’ worth of economical, unsubsidized hydrocarbon deposits in the ground right here in the US and Canada, and the infrastructure easily can be extended to reach into the deposits in our respective territorial and economic zone waters, as the People’s Republic of China already is doing, filling the vacuum left by the present administration’s slow-walking of drilling permits for American companies.

Additionally, the beef that “the barriers for new technologies in the energy industry” are tough is just a cynical red herring.  Those technical barriers existed for the hydrocarbon industries, also, as they were developing.  Why should solar and wind get special treatment?  Muro has no answer; he merely asserts the “need.”

Muro concludes with this long-standing “promise:”

In sum, onshore wind is likely just a few years away from true subsidy independence, while several forms of solar aren’t far beyond.

Like commercial fusion, we’ve been “just a few years away” for decades.  It’s an empty promise.

As Dr David Kreutzer points out in his argument against these subsidies, though,

Surely some alternatives to fossil fuels will be developed, but they will only work if they are affordable.  Wind and solar aren’t, and that isn’t changed by shifting the costs from consumers and producers to the taxpayers.

Bureaucrats and politicians shouldn’t be the ones deciding which technologies are the most promising or what timeline is too long or what losses are too deep.  The market will do a much better job of answering the question: are wind and solar power really viable?

Let’s get rid of the subsidies and find out.

A Tax for a Health Fiscal Cliff

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It joins Democratic Presidential Candidate Barack Obama’s enormous tax hike he has taking place at the start of the new year, and it also creates a health cliff for the nearby future as it actively stifles medical innovation in the US.  “It” is the 2.3% tax that will be charged to American medical device manufacturers—on top line revenue—sales—not on profit.  Former Governor and US Senator from Indiana, Evan Bayh (D, IN), offered some thoughts on this problem in a recent Wall Street Journal op-ed.

As a result of this problem,

For a typical company, a 2.3% tax on revenues equals a 15% tax on profits.  When combined with a 35% corporate tax and state corporate taxes, the tax rate for the medical-device industry will exceed 50% in most jurisdictions.

[This inflicts an] added cost of $30 billion—according to the Congressional Budget Office—to the industry.  This tax comes straight out of a company’s bottom line.  Because many devices are sold to hospitals, physicians and other providers through multiyear contracts, the prices are already locked in, so the tax cannot be passed on to the buyer.

Think about the effects this will have on medical innovation.  Governor Bayh did:

America is a global leader in medical-device production and sales.  Last year the US device industry earned $5.4 billion more in exports than we spent on imports of such devices.

Even more important to the average American is the industry’s role in saving and sustaining life.  Medical devices have contributed to remarkable advances in numerous areas: artificial hips and knees, and devices used in the treatment of cancer, and for angioplasty, vascular surgery and in-vitro fertilization, to name a few.  Many of these devices have not only improved the quality of life for patients, but also produced health-care cost savings—for instance, each time an angioplastic balloon made open-heart surgery unnecessary.

and

Especially hard hit could be the hundreds of small companies developing medical software applications. These apps promise to revolutionize the practice of medicine—for instance, by delivering blood-sugar test results for diabetics.

But now

Thirty billion dollars must be taken out of operations or R&D.  Who knows what lifesaving devices that might have been developed will fall victim to this tax?

What about jobs?

Many US device companies, in response, have already announced layoffs, canceled plans for domestic expansion and slashed research-and-development budgets.  This month, Welch Allyn—a maker of stethoscopes and blood-pressure cuffs—announced that it will lay off 10% of its global workforce over the next three years, but all of the jobs being cut are in the US[]

and

In my state of Indiana alone, Cook Medical has canceled plans to build one new US facility annually in each of the next several years, and Zimmer plans to lay off 450 workers, while Hill-Rom expects to lay off 200.  Stryker, based in Michigan, anticipates having to lay off 1,000 workers[]

and

[P]roduction is moving overseas, good jobs are going to Europe and Asia, and cutting-edge medical devices will now be produced elsewhere for import into the US.

Of course Obama and his Progressive Congressmen knew this when they wrote the tax; it’s part of why the entire bill was written behind closed doors in the back of Harry Reid’s office suite, and why Nancy Pelosi was so anxious to get the bill passed before “we can find out what is in it.”  So much for Obama’s concern for the little guy.  So much for Obama’s concern for the health of Americans.  So much for Obama’s concern for America’s innovation leadership.

Update: added the actual name of the man in the first paragraph.

A Social Security System Proposal

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Social Security, as we know it, is going to go broke in a few short years.  Demographics guarantee this.  When Social Security was instituted, it was a supplemental income program for our retired, who were expected to continue to rely on their own resources and those of their families for their retirement years.  Moreover, at that time, there were roughly 7 workers paying into the system for every retiree and a retiree lifespan in retirement was about 6 years.

Today, Social Security is expected to be an income replacement program.  Moreover, the number of workers paying into the system is around 3 for each retiree, and that number is falling.  Then, each retiree is expected to live for 17+ years in retirement.

But one thing has remained constant.  Each worker paying into the system is paying for someone else’s current retirement—the money paid in is not set aside to accumulate for the payer’s benefit.

I propose to change this in the following way.  It will eliminate Social Security as we know it, but it also will preserve and strengthen the promise of social security: a reasonably comfortable retirement for the retiree.  Privatize, entirely, Social Security.

Eliminate the payroll tax for both employer and employee (think about the immediate stimulative effect from reduction in the cost of labor of 6.2%).  However, require the employee to set aside 6.2% of his income from all sources, not just from wage income (just to keep it simple, and consistent with a tax proposal nearby).  Why 6.2%?  That’s the current employee payroll tax for Social Security, absent any temporary reduction.  Eliminate, also, the present upper limit on income (wages) subject to the Social Security payroll tax.  However, instead of this money immediately being paid out to someone else’s present retirement, it will be put into an account owned and managed by the employee, and the money will accumulate for his own future retirement.

Let’s look at the effect of this on a hypothetical man’s retirement.  Let’s say the man earned $100,000 per year in his last years of working.

Under the current system, that man retiring at 66 will receive $25,800 per year until 2033, when the Social Security Trust Fund will be exhausted and payroll taxes will only be able to support payouts at 75% of their nominal rate—our man, after having been retired just 20 or so years (never mind the 17+ years of an actuarial retirement), will see his payout cut to $19,400 per year (note that for this, I’m ignoring inflation and cost of living increases).

Now suppose our man has been socking away 6.2% for his, let us say, 40 years of working life, and he’s still making $100,000 in his last years.  Again, we’ll ignore inflation, and we’ll take a naïve position of his having started out making $20,000 per year and received constant annual pay raises to reach his present $100,000 annual income.  With his 6.2% set-aside each year naively left to grow with the market (the S&P500 historical growth rate has been 9.77% since 1926—a period including the Great Depression, the Carter Recession, and the Panic of 2008), our man will accumulate enough by the time of his retirement to withdraw over $55,000 per year over the course of a nominal 18-year retirement, or more than $29,000 per year, if he expects to have a 34-year retirement (i.e., live to 100).  And he won’t have a reduction to 75% of that because the government ran out of money.  Of course, this table napkin analysis ignores inflation, also, and it ignores leaving the remainder of the man’s accumulated retirement fund still invested—now perhaps in bonds.

Notice one other critical factor here: with privatized retirement savings in place of Social Security, each man will be working for his own future instead of working for someone else’s present.  With his own money at stake, the man will do a far more careful job of managing for his future retirement than the government already has done—with OPM.

There is, of course, the risk that the man may invest foolishly, or he may invest wisely but have a run of bad luck in the market—downturns do occur.  What happens to him in this brave new world?

First, look at what happens in the present situation, where the impending failure of the Social Security System is an empirical fact.  In this scenario, where the government’s management of our retirement accounts has failed, the disaster affects all of us—every retired individual; every soon-to-be-retired individual; and each of the rest of us, who must find a way to support these unfortunates.

If the man fails, though, whether through his folly or his bad luck, the effects of his failure is limited to him and his family; it is not a national disaster.  And these individuals will be few enough in number that help—a hand back up, generally, or support if his failure comes too late for him to recover—can come from his family, his local community, church and/or charity, and, yes, as a last resort, state government.

The Federal Bank of US Taxpayer

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In a new Bernanke hair-brained scheme, the Federal Reserve Bank said last week that it is going to quantitatively “ease” by buying mortgage-backed securities from the private economy, to the tune of $40 billion worth per month.  Nearly half a trillion dollars each year.  And it’s open-ended, meaning the Fed has no plan—no idea, really—of when it might stop.

Bernanke says this is necessary.

If the outlook for the labor market does not improve substantially, the committee will continue its purchase of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

Bernanke then said, in all seriousness,

[This move will] assure the public that the Fed will remain accommodative long enough to ensure recovery.

We don’t have a single number that captures that, but we anticipate that we’ll have to do more and we’ll do enough to make sure the economy gets on the right track[.]

In other words, he doesn’t have a clue what his decision criterion should be, but he’s going to decide, anyway.  And more so, as time goes on and his nonexistent milestone isn’t met.

And

These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month [including its existing long-bond buying “plan”] through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative[.]

There are a number of questions, though.

Why are we taxpayers being put on the hook for these private economy instruments?  If these securities are failing in our economy, why should the public have to pick up the tab?  If they aren’t failing, whence the need to take them off the banks’ hands?  What ever happened to free markets, responsibility, and accepting consequences, as well as reaping rewards?

And these questions:

The Fed has been artificially suppressing interest rates for the last three-plus years.  That suppression already has lowered my own mortgage rate from 6+% to nearly 3.5%.  What does Bernanke expect to gain from suppressing mortgage rates directly?  The inflation rate this year is 1.7% month on month, and 2% year on year through August.  The August interest rate on a one-year Treasury Note is 0.16%: he’s already suppressed interest rates to the point that we’re paying the government for the pleasure of lending it our money.  What does Bernanke expect to gain?

These artificially suppressed rates have a number of negative effects.  By distorting the market for debt instruments, the Fed is making it difficult, if not impossible, for investors accurately to assess value of the debt of borrowers—and so is making it unnecessarily difficult, and risky, to lend.  How does the Fed plan on redressing this failure?

By artificially suppressing interest rates, the Fed is actively and extensively damaging those who’re committed to, or dependent on, fixed income instruments, like bonds, for their income.  Folks like retirees.  How does the Fed plan on redressing this failure?

Savings accounts have become utterly useless—the interest rates here have been good approximations of zero for the last four years.  Savings accounts used to be an effective means through which financial institutions could accumulate funds for lending to borrowers—like home-buyers and businesses looking to expand their operations. How does the Fed plan on redressing this failure?

Our economy will recover, eventually.  And interest rates will rise.  Catastrophically, if all the money the Fed is pumping into our economy with…ideas…like this one drives inflation skyward.

On top of this, though, the Fed is creating another time bomb, one which it has no hope of controlling.  When interest rates rise, and the cost of borrowing goes up, for lending institutions as well as for borrowers, as the former search for funds to loan to the latter, those lenders still will be sitting on all those mortgage loans let at artificially low rates.  Those low rates in a healthy economy (let’s skip over the high inflation, high interest rate economy) will be far below then-market rates, and so those existing mortgages, mortgages with which the lender still will be stuck, will not be generating enough income for the lenders to continue to loan.  For up to 30 years in the mortgage market.  Can you say, “S&L bankruptcy?”

And, by the way, as Federal Reserve Bank of Richmond President Jeffrey Lacker said Saturday,

Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve[.]

Or for any part of the government.