Monday, June 29, 2009

Part Two: Cap and Trade and the 1970's Oil Shocks

Mark Twain once said "The past may not repeat itself, but it sure does rhyme".

If you remember the 1970's, a decade worth forgetting, you might well remember the following and relate the items to Cap and Trade:

*The 1970’s - 1981 economy/recessions suffered “oil shocks”.

*Cap and Trade would create something larger. Rather than a 1970’s “oil shock” it would be an “all energy shock”. This time around add in electricity and natural gas to the oil shock equation .

*There were cascading price increases which effected producer products and consumer products in the 1970’s due to the oil shocks.

*The higher oil costs of the 1970’s left consumers with less disposable income. Meanwhile, the consumers armed with less disposable income found consumer good and services rising in cost. Less disposable income in the face of rising prices. Then came spiraling wages followed by higher prices. At the height of the recession came: 21% mortgages, +10 inflation rate, money market funds paying 15%, and high persistent unemployment.

That was the 1970’s.

Cap and Trade would equate to the 1970’s Oil Shocks.

Sunday, June 28, 2009

Obama Administration's Unemployment and Job Creation Conundrum

“We have tried spending money… We are spending more than we have ever spent before and it does not work… After eight years of this Administration we have just as much unemployment as when we started.” - Henry Morgenthau, Jr., FDR’s Treasury Secretary, 1939

(1) simultaneously deploying Quantitative Easing and Keynesian Government Deficit Spending, in a current environment of high government debt (remember these two theories were developed in low or zero government debt), creates uncharted economic waters with plenty of unintended consequences,

(2) the “Stimulus” package of $800 billion is unlike prior Keynesian Infrastructure Spending Plans. The $800 billion is more akin to Social Engineering than Infrastructure Spending . That is, prior historical Keynesian Spending Plans were Infrastructure Spending Plans creating short term jobs from Infrastructure spending,

(3) no incentives exist in the current government policy for Private Capital Formation leading to Private Sector job creation,

(4) The current stimulus plan is based on wealth transfer and the recipients of the wealth being low income earners who have a 100% propensity to spend hence creating “stimulus“,

*** an odd out item is the Theory of Low Wage Earners having a 100% Propensity to Spend. Its an economic phenomena. However, to use this particular economic phenomena as the basis for a stimulus plan is strange to say the least. If one studies the theory you find that low wage earners experiencing additional income merely buy additional Staples of Life. Completely understandable that their marginal propensity to spend is within Staples. However, what is the multiplier effect of additional Staples purchased?

(5) disposable income of businesses and consumers is being threatened by the expiration of the Bush Tax Cuts, proposed increases in State and Local Government Taxes and Fees, proposed Cap and Trade energy tax, proposed National Health Care "down payment", proposed Capital Gains tax increase, etc., etc..

All of these ingredients bring you back to 1939 and Henry Morgenthau, Jr. and his comment above. If Henry was alive today he would be interested in the lessons learned from the Great Depression.

The Obama Administration likes to cherry pick certain lessons from the Great Depression and skip over all the remaining lessons. You never hear that taxes were increased on businesses and consumers during the Great Depression which depressed Private Capital Formation. Private Capital Formation which leads to Private Sector Jobs was squelched. How about the lesson that Keynesian Government Deficit Spending is by definition short term in nature, creating short term jobs, that must be replaced by Private Sector Jobs.

With rising taxes reducing disposable income and absolutely no incentive for Private Capital Formation, any short term anemic economic recovery will be a jobless recovery. High unemployment will likely persist.

State and Local Government Debt and the Tax Revenue Stream

One might hold the contention that during the last decade, State and Local Governments have been spending on expanding current services/capital projects, adding new services/new capital projects, and hiring a ton of employees, based on ever growing tax revenue.

That the expanded service aspect, in many cases, takes on the aspect of entitlements. That the expanded services/expanded capital projects went beyond the tax revenue stream and large amounts of debt was assumed to finance such items.

The powers-that-be that added the debt had the same mind set regarding tax revenue that those in the housing market had regarding home prices: what goes up continues to go up.

However, the tax revenue stream was a bubble that has burst and now their budgets are in shambles. One might harp upon this item: debt load acquired by these government bodies is unsustainable with tax revenue decreasing at an increasing rate. That the debt assumed was based on rising tax revenue that has now declined precipitously.

When tax revenues were rising, and this rise in tax revenue producing the mind set that the rise in tax revenue would continue forever, State and Local government bodies not only overspent, they magnified the overspending by acquiring debt to produce services/capital projects beyond that available from their general revenue stream.

Now that these government bodies must bring their budgets into equilibrium with the decreasing tax revenue, one might conclude they are not reaching budget equilibrium due in part to the following:

(1) these government bodies need to shrink the expanded work force they created. In many cases the work force is unionized and has major political clout. That is, this unionized work force is generally political supporters of the same legislators, governors, mayors, city councils, etc. that were in charge of creating the positions. That the same legislatures are in charge of reducing or eliminating the same unionized jobs they themselves created is clearly a conflict of interest. Therefore, great resistance occurs and job cuts are marginal at best,

(2) services/entitlements created are causing their own lobbyists to resist the cuts. For example, In North Carolina proposed cut backs has fostered a threat of a lawsuits,

(3) expanded capital projects financed through debt and based on the mind set of ever increasing tax revenue is a fixed cost that becomes increasing difficult to pay given tax revenues decreasing at an increasing rate,

(4) in some cases State and Local Governments cut their budget yet add back pork barrel spending.

Hence their budgets do not reach equilibrium which lends itself to the question of whether the debt issued in the past can be serviced. That is to say, the budgets were bloated in the first place. That major cut backs are needed to match revenue.

However, the cutbacks may need to be even deeper then merely reaching current budget equilibrium given the debt load taken on during the past 10 years. That is, the debt acquired requires budget austerity for years to come in order to service and retire the debt load acquired.

The Political Economy of the debt is that State and Local Governments do not have the political will to reduce labor and services. That candidates seeking election and re-elected political figures have relied on "spending" to indirectly buy votes. That the recipients of the spending are resistant to forgo services that benefit them. That unions are resistant to reductions in their union members.

The answer: Raise taxes? One might conclude that raising taxes merely perpetuates the problem outlined above.


However with 10%+ average unemployment, loss of household wealth, de-leveraging, etc. the public is highly resistant to tax increases. Further, tax increases may well be be predicted by The Laffer Curve and result in lower revenue. Finally, tax increases depress consumption and private capital formation which will exacerbate the unemployment rate.

Therefore, one might conclude an economic train wreck in State and Local government debt. It may very well acquire a cascading effect and certainly will affect new debt issuance.

Friday, June 19, 2009

The Forgotten Economic Participants

In the Macro Economics sense, many people are looking into how we got into a financial crisis and deep recession. Marco Economic analysis of the financial crisis complete with Toxic Assets, Credit Default Swaps, etc., etc..

In the Macro Economic sense, many people are looking into how Government Response of simultaneously deploying Quantitative Easing and Keynesian Deficit Spending, in an environment of current high Government debt levels, will effect the economy going forward.

Here is an interesting Macro Economic item that gets no attention: What about the consumer and business of all economic sizes and shapes, from all Political Quarters, that entered the current crisis/recession with low debt, cash on hand, balanced budget, and secure credit lines?

Little attention is paid to this section of consumers and businesses. Believe it or not, they do exist in large numbers.

This particular group of prudent consumers and businesses: How do they react during the recession? Did they spend more or less? Did they cherry pick bargains since they were in a position to do so? How does this group react to the end of the Bush Tax Cuts expiring 01/01/2010? How does this group of prudent households and prudent businesses react to spiralling Government Debt? What about the bail outs of financials and car companies?

This particular group of prudent consumers and business do not need to de-leverage. The falling values of residential property and commercial property are concerns but are not a crisis to this particular group. This particular group were in a position to capitalize on falling prices in many sectors and conversely could weather $147 a barrel oil.

Studying this particular group is valuable. What this particular group did correctly is as important as what went wrong for other groups.

Thursday, June 18, 2009

Recall the Stimulus?

Below are two links. One is a discussion by Larry Kudlow on "Recall the Stimulus". The other link regards a reference within Kudlow's column to Scott Grannis.

Just like the wrong e-mail being recalled by a sender, recall the wrong stimulus plan.

This is a rather interesting concept.

Recall the Stimulus. This time read the entire 1000+ pages. Then discuss the document. Edit the document. Then try again.

Why not?

Saturday, June 13, 2009

Past Social Engineering: Unsound Financials Past, Present, and Future

Rewind to the 1960's and Lyndon Johnson's "Great Society". Rewind to the 1930's and "The New Deal" of Franklin Roosevelt. The Social Engineering Programs developed over the years are very familiar to every citizen: Social Security, Medicare, and Medicaid.

The political aspects of Social Engineering aside, are Social Security, Medicare, and Medicaid programs well funded? Are the Economics of current entitlements sound? Its common knowledge that the programs mentioned above are not funded correctly and pose a huge unfunded liability stretching well into the future. That benefits outweigh the funding.

In other words, the Social Engineering programs of the past are broken and need repaired. Does it make good Political Economy to add additional Social Engineering Programs to a current system in disrepair?

Rewinding again to the 1960's and 1930's, the above mentioned Social Engineering plans, when initially debated and consequently introduced, were these programs portrayed as Financially Sound? When the politics were debated for these Social Engineering Plans the public was sold on the sound financial nature of the plans. Back to the future in 2009, the plans are a financial nightmares.

Wouldn't any new Social Engineering Program be portrayed by supporters as Financially Sound? Of course it would. Plenty of charts and graphs showing the social benefit and the soundness of the proposed cost/revenue. However, since we know the track record of past Social Engineering Programs as financially unsound, why would we believe any new entitlement program would be financially sound?

Before any further debate occurs regarding National Health Care aka Socialized Medicine, the financial dynamics of entitlements of the past need addressed and solved.

Thursday, June 11, 2009

De-couple Economic Policy and Social Engineering

Keynesian Deficit Government Spending and Quantitative Easing are two Economic Theories developed in an environment of low or zero Government Debt. Simultaneously deploying both Keynesian Deficit Government Spending and Quantitative Easing in an environment of high current Government Debt, with debt increasing at an increasing rate, is at best a very dicey experiment.

The US Economy can likely withstand the above mentioned propositions along with its many, many unintended consequences. However adding Social Engineering such as Nation Health Care, Cap and Trade, etc., etc. will cause a major Economic Train Wreck. The economy needs no costly changes at this time. Sorry, we are broke.

Add the laundry list of Obama proposed Tax Increases and it becomes a spectacular Economic Train Wreck. You can not depress Consumer and Business consumption with increased taxes during a major recession. You can not depress Private Capital Formation with increased taxes, leading to Private Sector Jobs, during a major recession.

Economic Policy and Social Engineering need de-coupled and handled as separate items.

The Economy needs repaired first. Even after economic recovery no added entitlements. Why? Social Engineering of the past needs repaired first. The current entitlements represent a huge unfunded future debt and must be accounted for, budgeted for, and corrected.

Sunday, June 7, 2009

State Government Budgets and Budget Equilibrium

About one third of the 50 States have major budget problems in relation to spending versus revenue. To listen to the State Legislators, of the States in financial problems, the budget size and revenue short fall seems to be characterized as a "surprise".

Surprise? More like a Train Wreck that has been advertised, predicted and known for over a decade.

Moreover, the State Budgets that are being cut are not reaching equilibrium with revenue due to the lack of government payroll cuts and/or pay cuts. State Legislators will cut all sorts of service programs but are leaving State Government Payrolls basically stable.

With the Private Sector laying off millions of workers and the remaining employed, in many cases, taking major hair cuts in wages, why is it that State Government doesn't follow suit? With economic activity shrinking leading to revenues declining in the Private Sector, jobs must be shed. With declining tax revenues affecting the Public Sector, no corresponding labor reductions exist.

The unionized Government work force, and that unionized work force in many cases being large political supporters of Governors and State Legislators, there becomes no political incentive for State Payroll reductions. Likely the payrolls of the States remain constant due to politics not economics.

State Budget cut backs are related to a movement toward revenue/service Equilibrium. For the last decade many State Governments have provided champagne services on a beer budget. State budgets based on providing ever increasing and expanding services based on increasing tax revenue. That the increasing tax revenue stream was further used to finance debt used to increase services that could not be paid for on a current account basis.
When tax revenues suddenly fell due to the Macro Economy in recession, State Legislators were caught in the same mind set as the participants of the Housing Bubble: what goes up continues to go up.

Equilibrium in State Budgets will not be achieved until service cuts backs are matched with corresponding employment cut backs. Currently there is movement toward budget/revenue Equilibrium in the several States, however its merely movement. Equilibrium will not be achieved until State Government Payrolls are reduced significantly.

Finally, due to a decade long over spending, based on the mind set that tax revenues would increase perpetually, large debts have been assumed by the States. Even after economic recovery, State services and State Employee Payrolls have to remain constant as the large debt roll ups need paid off due to over spending in the past.

Thursday, June 4, 2009

US State Government Debt/Revenue/Employment

Another major speed bump in the recovery of the US Economy is raising its ugly head: state government debt overhang.

California and Michigan are of course the twin poster children of State Government Debt. However, about 1/3 of the States have serious problems.

(1) If the States raise revenue through higher taxes they will directly depress private consumption (Demand) and possibly reduce their own revenue (Laffer Curve),

(2) If states reduce their budgets they must lay off government employees further increasing unemployment,

(3) State governments continue on their crash course, issue more bonds with the possibility of federal government guarantees, hence indirectly adding to Quantitative Easing (indirectly print money).

Moreover, this entire state government debt problem was predicted and published in an article in 2001 by The Economist: Red Ink Rising.

Red Ink Rising was later changed to: America's states go into the red.

Tuesday, June 2, 2009

Countervailing Economic Policy

Quantitative Easing and Keynesian Deficit Government Spending are both theories developed in an environment of low or zero government debt and significant deflation.

The two theories have only been deployed simultaneously one time in a modern political economy: Japan 2001-2006. Japan remains in recession (1989- present).

The Obama Administration is simultaneously deploying Quantitative Easing and Keynesian Government Deficit Spending in an environment of high current government debt, with debt increasing at an increasing rate.

The high debt environment ends up making Qualitative Easing and Keynesian Deficit Government Spending Countervailing Economic Policy with unintended consequences adopting a multiplier effect cascading across the macro economy e.g. dollar devalued, commodity prices increase leading to the specter of inflation, treasuries experience interest rate increases leading to mortgage rate increases, further depressing the housing market, etc. etc..

Meanwhile, since Keynesian Deficit Government Spending supposedly is temporary in nature until Private Capital Formation rebounds.........there is absolutely no economic incentive in the Obama Plan for Private Capital Formation. Hence Private Capital Formation depresses hence leading to a jobless recovery.

Finally, the laundry list of Proposed Tax Increases to finance Government Deficit Spending depresses business and consumer spending becoming yet another countervailing power. The laundry list of tax increases affect so many business sectors and consumers in so many ways that the tax increases also adopt a cascading multiplier effect depressing demand.

The result is Economic Policy know as Chasing Your Tail. Welcome back to the 1970's.

GM Largest Bankruptcy Ever in USA?

GM is not the largest bankruptcy ever in the USA. GM is the largest Industrial Sector bankruptcy ever in the USA.

It might be a better perspective to list the hierarchy of the largest bankrupt entities in the USA in light of the GM bankruptcy:

(1) US Federal Government,

(2) State Governments,

(3) County Governments,

(4) City Governments.

Many observers point to GM's bankruptcy being a function of Poor Management and a Unionized Work Force. Could one then make the argument that all forms of US Governments are run by Poor Management and function with a Unionized Work Force hence leading to bankruptcy?