It's Still The Economy, Stupid

Thursday, January 15, 2004  

Taibbi on Democratic weakness

Another soon-to-be classic over at the NY press. Matt excerpts a NY Times piece by James Traub on Howard Dean.

Traub: A few weeks ago, I asked Howard Dean how, given his vehement opposition to the war in Iraq, if he felt he could overcome the Democrats’ reputation as the antiwar party. "I think you’re still in the old paradigm, which says that they’re the party of strength and we’re the party of weakness," Dean admonished me as I sat across from him on his campaign plane. The chaos in Iraq, he said, had upended the old stereotypes. In John F. Kennedy’s day, Dean pointed out, the Democrats enjoyed the reputation as the party of resolution. "I think this may be the year to regain it, oddly enough," Dean said.

Taibbi: I laughed out loud after reading this paragraph. The humor here was in imagining the reaction of Noam Chomsky to the article’s very premise. Here was the New York Times, vilified by the right as the great Trojan Horse of leftist propaganda, writing an iconic piece whose premise held that the Democratic Party–the Democratic Party!–needed to overcome its anti-war reputation. And there was Howard Dean, almost universally described in the media as the next incarnation of Leon Trotsky, agreeing with this premise.

Traub concludes his article: Strong and wrong beats weak and right–that’s the bugbear the Democrats have to contend with. George McGovern may have had it right in 1972, but he won Massachusetts, and Richard Nixon won the other 49 states. McGovern recently said that he is a big fan of Howard Dean, whose campaign reminds him very much of his own. Dean may want to ask him to hold off on the endorsement.

My laugh out loud moment was here:

As for kicking ass, forget about it. Any party that has to roll up its shirtsleeves and pleadingly show off its biceps to James Traub is doomed from the start. The way to show voters that you are strong is to walk into the room with James Traub and punch him in the face. Then, as he crawls around on the floor picking his teeth out of the carpet, you ask him: "What was your question again?"

Such a display would doubtless trigger all kinds of press reaction. But there certainly wouldn’t be any more 7500-word treatises on your "toughness" problem.

The rest was a tongue-in-cheek exploration of how the Democrats could use fascism, but if you don't take it literally it is easier to enjoy.

posted by Teddy | 7:29 AM |

Light blogging til March

Busy season has come and that will restrict the amount of blogging I can do. Meanwhile, here's an interesting article that pretty much explains why I never watch any pundits or television in general: they don't really inform us but rather are selling something.

posted by Teddy | 6:50 AM |

Tuesday, January 13, 2004  

More labor law violations at Wal-Mart

Sigh, What else is new?. Apparently not a lot of Wal-mart workers eat food, and therefore don't need lunch breaks. And somewhere inside the Wal-mart is an actual functioning high school that teaches those child workers during school hours. Is this what we will tolerate for a $4.50 spatula?

posted by Teddy | 11:56 AM |

Ten Rules of Investing in the New New Era

Back on March 23, 2000, Bill Fleckenstein published a piece at Silicon Investor titled "13 rules of investing in the 'New Era'". While the article is prominently posted on the wall of my office, the link seems to have expired long ago over at SI, so I'll have to dictate the gist of it.

The rules were for the stock market and the rules were: 1) Invest exclusively in equities, 2) Don't diversify, 3) Go for growth, 4) Forget about dividends, 5) Ignore valuations, 6) Buy stocks of companies with little or no earnings, 7) Buy on margin, 8) Buy first, research later, 9) Buy on the dip, 10) Be a momentum investor, 11) Be greedy, 12) Buy and hold forever, 13) Ignore history, listen to propaganda.

While the titles don't do service to the description of each rule, the article really captured the mentality of investing at the peak of the bubble. That the article was published literally a week before everything came unraveled multiplies it's importance. In the interest of the public good, I'd like to update and condense these rules for 2004.

1) Invest exclusively in housing
Savings doesn't yield anything. God knows who's ripping off your mutual fund. The stock market goes down, too. We know that now. But housing has gone up every year for the past century and will continue to do so. Keep a small amount in a checking account for current expenses and throw everything into your house. Did you see the "future millionaires" series on Every single one had 80% or more of their net worth in their house. You'd be a fool to put your money anywhere else.

2) Buy as much house as possible
You're an unmarried couple with no kids? So what?!? Buy that 5000 square foot home with the pool and four car garage! You can't make any money on a three-bedroom two-bath with a one car garage and everyone knows it! Townhouses and condos? Neighbors on the other side of a wall mean no appreciation. Take 60% of your income and calculate what house you can afford with that monthly payment. Then add $50,000 for the bidding war that will ensue when you play with the big boys and girls. Even if you have no money for a down payment, you can easily find a lender willing to let you put nothing down and there are construction companies that actually pay you to put a down payment on one of their houses. What could be better than that? Think of the tax deduction! You could have the income of a Rockefeller but still be in the 10% tax bracket. Boo-yeah.

3) Releverage annually
After several years, your house may have appreciated so much that you have TMES or "too much equity syndrome". You really only need 20% in equity to escape PMI, so now's the time to buy what you've always wanted. That four-car garage can fit at least two Hummers, and if your neighbors complain just run em over. Freakin tofu-eating hippies.

4) Forget fixed rates
Thirty-year fixed rate mortgages are for losers who lived during the Depression, and we know that will never happen again because of Alan Greenspan. Think of how much more house you can get with a 3.5% 1-year ARM rather than a stodgy old 30-year fixed rate mortgage at 6%. Who lives in a house thirty years anyway? You'll always have to be able to cut and run in an instant for a more expensive mansion, so keep those terms short, stupid!

5) The house is the new bank account
If you're ever running low on cash, just call up your friendly mortgage broker. He/she will easily be able to get you into a lower rate mortgage and you can take out as much equity as you like. Out of equity? How about a nice 125% home equity loan from your local credit union at 3%? Still can't get equity? How about asking your broker to get another appraiser. I'm sure the last one was just drunk or something, and a sober one would see the house is worth at least $10,000 more.

6) Improve, improve, improve
There are very few investments better than the $20,000 kitchen with Corian countertops and oak cabinets. Not only does it make the house look nice, but it raises the value by twice that. Rip out the carpet and add wood floors. Finish that basement. Two-year old appliances are energy burning fossils that don't look nice. Two words: crown moldings. And is there any unimproved space on your lot? Knock out that wall for another room or if you can, add a whole new floor. A five bedroom always sells for more than a four bedroom and you can never have enough bathrooms. Don't worry about improving the house too much, because all your neighbors are too and you'll never price the house out of the market that way. Home Depot and Lowes have plenty of financing available, and the way they're building stores one is sure to be within several yards of your home. Reserve your parking spot in the first row now.

7) Find neighbors as greedy as yourself
The key to finding a good neighborhood is neighbors as greedy as yourself. Drive down the street and count the Hummers, Mercedes', BMWs, Lexus', and other luxury cars. Count the pools and check out the landscaping. If you find an area that looks just marvelous, yet prices are still affordable, you're in profit heaven, baby. If you can't find the place, search for the most run down 2 bedroom in a rich area and raze that baby. There should be plenty of space for your new mansion and you won't have to worry about getting your 750sl keyed.

8) Ignore doomsayers
How many years are those idiots going to predict a bubble when we all know prices don't go down (in good areas) and even then, housing markets are local. I could care less if NOrthern California has problems, anyway, because all my neighbors have Mercedes and the school district is fantastic.

9) Get your real estate/mortgage broker/banking license
Did you know real estate agents get 3% of every house they sell? At today's prices? If you're tired of your loser job, what better way to make a mint than to sit in beautiful open houses handing out jars of apple butter with your picture on it? Just a couple of sales a year can pay the rent and there are millions to go around. If you don't like sales or are better with numbers, go to work for a mortgage lender and they'll come to you. New financial products and services come along every day, so there's always a demand for new employees to sell them.

10) If your equity runs high, buy another house!
TMES is a major problem with home prices rising 10% a year forever. If your equity gets too high no matter what you try to do to reduce it, buy another home! Get a second mortgage, rent it to cover the payments and double your money as the price goes up.

posted by Teddy | 11:25 AM |

Borrowing ourselves rich

Marshall Auerbeck has a good commentary today on Alan Greenspan's early January speech at the American Economic Association.

Before Alan Greenspan breaks his arm giving himself too many congratulatory pats on the back, he ought to consider the foregoing quotes, especially his own. The Fed Chairman has certainly been in a festive frame of mind as we have come into 2004. In a speech made on January 3rd, Greenspan confidently asserted that there was at least tentative evidence to suggest that "our strategy of addressing the bubble's consequences rather than the bubble itself" had been successful.
There are signs that the rest of the world is unprepared to join in the ovation which Greenspan clearly thinks is justified under the current circumstances. In spite of the best efforts of Asia's central bankers, it is highly telling that the dollar has continued to sell off and gold continues to rise. More significantly, is that such dollar depreciation, although accompanied by some hand-wringing amongst French and German industrialists (who perceive their export markets under collective threat as a consequence of the euro's record-breaking strength against the greenback), is not engendering any significant reaction from Euroland's monetary authorities. They appeared prepare to let the dollar's freefall continue indefinitely. If anything, recent comments by European Central Bank President Jean-Claude Trichet, who said the euro's 22 per cent gain in the past year would not prevent the region's exports from increasing, appear a rebuttal to Mr Greenspan, especially as such remarks came on the heels of the Greenspan and Bernanke speeches. In effect, Trichet appears to be telling American policy makers, "You're on your own." concludes

In contrast to Mr Greenspan's musings, a more accurate characterisation of current reality is that an unsustainable boom in consumer spending fuelled by credit has simply replaced the unsustainable bubble in corporate expenditure of the late 1990s that was driven by corporate debt. In view of these continued imbalances, we view the bear market as merely interrupted, rather than eradicated; at some point in the near future it will return. But when this latest bubble pops appears to us to be very much a case of Asian central bank discretion, rather than "brilliantly conducted" Fed policy.

Echoing this analysis is Bill Gross' commentary in today's WaPo.

The United States is overextended, not just militarily but economically. We are trying to do too much, borrow too much, spend too much, and sooner or later we will have to suffer the consequences. We are a country in the beginning stages of what can best be described as hegemonic decay. Empires take decades if not centuries to wither, a process more clearly viewed through a rearview mirror; Edward Gibbon's masterful account of the decline and fall of the Roman Empire is perhaps the greatest example of this truth. But here and now, we're much less inclined to Gibbon's viewpoint than we are to Alfred E. Newman's. "What, we worry?" is pretty much the national motto when it comes to our finance-based economy and its future prospects.

Gross paints a pretty accurate picture of the popping of a credit bubble instead of the frantic reflation of one.

Pretend that you're a head or co-head of a household. You earn a good salary, but it never seems to be enough. There are bills to pay, the Joneses to keep up with, and you've had your eye on that goofy Hummer for at least a few months now. You'd like to save money, but you can't or you won't, so you don't. As a matter of fact, each year for the past decade or so you've had to borrow 4, 5, 6 percent of your annual income to pay for what you want. You're running a personal deficit. But that's still okay, you figure. You're strong, vibrant, prospects are good, and there's no way you shouldn't be able to handle it. You can grow your way out of current liabilities and have more than enough to pay for future obligations such as college for the kids, that faraway retirement for you and your spouse, and health care, if that should ever come up. And your creditors undoubtedly will see it the same way. They know a good risk when they see one.

But then something happens. Your company's prospects sour, your pay raises virtually vanish, your health deteriorates, your family life sours -- who knows? With no savings and a boatload of debt, the wheels all go into reverse. Creditors are not so friendly. Not only will they not lend you that 6 percent of your salary every year but they want a higher interest rate on what you've already borrowed.

The United States is strikingly similar to the Alfred E. Newmans just described. It's strong and vibrant, with a future seemingly as bright as that of any country on the planet. Productivity is soaring, markets are recovering, its salary (or gross domestic product) shows decent increases almost every year. It goes wherever it wants to go, its Humvees symbolic of global military domination. Where's the decay in this hegemony?

I'll interject here that the housing bubble has been very, very good to me. Eleven months after buying my first home, its appreciation allowed me to refinance away my entire second mortgage, and that at a lower rate than my original first. I felt like Yakov Smirnov "What a country!".

But I avoided taking out the 5/1 ARM that all the kool kids were taking. I don't want to even risk a nightmare if interest rates were to rise to, say, 8% at any time during the mortgage. It would not only mean a much higher monthly payment later, but would mean that many fewer people could afford my house. Thinking in reverse, to get a $2000 monthly payment on a 30-year mortgage at 5.5% means buying a $352,250 house. At 8%, the same payment would only buy a $272,565 house. Lower-interest rates have gone hand in hand with the housing bubble. If rates were to rise (more significantly than the 1% they jumped in 2003), it would likely spell disaster for home prices.

A couple friends said, "Oh, but you could refinance again before the fixed-rate term was over". If housing prices were to decline even a little, that would not be an option. The median price of a house in San Diego is now over $600,000. Just 5% of that amount is $30,000. For many buyers, that would be their ENTIRE equity stake in the house. Refinancing on a house with negative equity?Sorry, I'm not gonna go out like that.

Bill Gross's nightmare scenario is that East Asian countries would pull the plug on U.S. borrowing.

Because China's monthly trade surplus of $10 billion-plus with the United States implies a $120 billion annual addition to its dollar reserves, there will come a time when its hundreds of billions in holdings of U.S. notes and bonds look a tad too risky. In turn, the hundreds of billions that Japan and other Asian countries have been buying to keep their currencies competitive with the Chinese yuan and the U.S. dollar will be subject to a sanity check as well. At some point our Asian creditors will wake up and smell the coffee. Perhaps there will be dollar or Treasury note sell-offs or a revaluation of the yuan and then the yen. In any event, we pay the price: higher import costs, a cutback in spending on cheap foreign goods, rising inflation, perhaps chaotic financial markets, a lower standard of living.

China's willingness to buy our bonds, and its philosophy of fixing its currency to the U.S. dollar, will one day be tested. And should it lose patience, all its neighboring Asian states will move in near unison. U.S. interest rates will rise, our goods in the malls and the showrooms will be less affordable, and the process of national belt tightening and increased savings will have begun.

This jump in rates could happen extremely quickly, because speculators on interest rates have been banking on the Federal Reserve to keep interest rates low indefinitely. The Federal Reserve, however, only controls the Fed Funds rate, not the 30-year mortgage or the 10-year Treasury bond rate that parallels the 30-year mortgage rate. Ten-year treasury yields rose over 1% in under two weeks back in July 2003, and nearly unhinged the interest rate derivatives market. When speculators, which should include a lot of households with very high LTV mortgages as well as shiny new ARMs, run into trouble, the tendency is for everyone to rush out the door as soon as possible. The amount of money invoved has become staggeringly huge. The value of household real estate in the U.S. as of June was a cool $14 trillion (probably closer to $15 trillion today). Interest rate derivatives run in the tens (and possibly hundreds) of trillions$ in notational value. The GSE's (Fannie/Freddie/FSLB) issued $1 trillion of debt in 2003 alone. A major dislocation could leave most people financially crippled for years in a matter of weeks.

Meanwhile, a very low Fed Funds rate means low CD, savings, interest checking and money market rates, and very little reason for Americans to save money. The longer we keep rates low, the longer we remain exclusively reliant on the kindness of strangers to fund any borrowing. If the Fed keeps rates low as all other rates rise, this only enhances the dependency. Again, while things haven't fallen apart, the numbers involved have become mind-bogglingly huge. Japan bought nearly $30 billion of U.S. treasuries in two days and the Yen still fell. The Federal Reserve, incidentally, has around $20 billion in foreign reserves TOTAL.

The recent economic strength hasn't been comforting to me at all. In fact, every once in awhile I have to choke back vomiting in terror. It's run against every economic truism of the 20th century and that certainly isn't right. Ed McCarthy puts it best: you can't borrow yourself rich! Moreover, the conventional wisdom is starting to turn, much like it did against the stock market in late 1999. Rather than forecast the recovery indefinitely, like investment spending and the stock market rally was back then, the opinion has turned to "It can't last, but I don't want to predict when it will end". I can assure you that it won't be pleasant to be exposed to risk when it does.

posted by Teddy | 10:01 AM |

The trade deficit and the dollar

Kash over at Angry Bear raises an important point about the trade deficit.

...the US dollar has lost around 15-20% of its value against its trading partners, which means that imports should have cost the US 15-20% more over the year. The fact that they only cost about 2% more tells us one thing: importers and/or foreign firms who sell in the US have substantially cut the price that they're willing to accept, presumably in order to keep market share in the US.

Economists call this phenomenon "exchange rate pass-through", and it is crucial to understanding if the weaker US dollar will help the US trade deficit. If firms selling imports in the US are accepting lower prices in order to maintain their market shares, as this report seems to suggest, then the weaker dollar will not reduce imports at all. That's why the decline in the dollar may have less of an impact on the US's trade balance than many think.

I'd add a couple of things to this analysis. The price of our imports and exports have the same hedonic deflator as with consumer and producer prices. Computers and other electronic goods are particularly affected by hedonic adjustment, because the price is adjusted by "quality" improvements such as processor speed or chip capacity. This distorts the amount of "exchange rate pass through" by understating the rate of inflation across the board.

Our increasing dollar volume of imports would seem to indicate that in nominal dollars, we are indeed paying more for imports regardless of what the price indices say. In nominal dollars, imports rose $77.7 billion in the past year while in constant (deflated) dollars imports rose just $39.7 billion. The deflators reduced the increase in imports by nearly 50%! While our economic growth could also increase our imports, I note that in the third quarter imports rose by $13.3 billion compared to $17.2 billion in the second quarter, when GDP growth was just 3.1%.

The second issue is that there is a substitution effect on our imports similar to any set of goods. As China and Japan have protected their currencies more than Euro-based nations, their imports become cheaper and importers buy more from those countries. This underweights those countries in a trade-weighted index. This effect is undoubtedly small, though.

The third issue is the large weight of oil prices in the import index. Most oil exporting countries keep their currencies relatively fixed to the U.S. exchange rate because their transactions are valued in dollars. Here are the performances of currencies from major oil exporting countries over the past year: Russia +10%, Kuwait +2%, Saudi Arabia 0%, Mexico -3%, and Venezuela -6% - not quite as strong as the +22% appreciation of the Euro.

All these phenomena, along with exchange rate pass through, help to shield the U.S. from the effects of a declining dollar. When the dollar began a major decline in 1986-87, import prices in 1986 actually fell year-over-year. Only in 1987 did import prices rise, and this was only by 10%, compared to a 50% decline of the dollar versus the Swiss Franc and Japanese Yen, a 45% decline versus the German Mark, a 35% decline versus the French Franc and a 30% decline versus the British Pound.

posted by Teddy | 8:20 AM |

Monday, January 12, 2004  

The recovery mirage

Steve Roach no like.

Contrary to popular spin, the US labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses — a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments — temporary staffing, education, and healthcare — which collectively added 286,000 positions in the final five months of last year. The “animal spirits” of a broad-based hiring-led revival by US businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost-areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services.

The modern-day US economy has never been through anything like this. Fully 25 months into this so-called economic recovery, private-sector jobs are still about 1% below levels prevailing at the official trough of the last recession in November 2001; at this juncture in the typical recovery, jobs are normally up about 6%. Had Corporate America held to the hiring trajectory of the typical cycle, fully 7.7 million more American workers would be employed today. Moreover, the current hiring shortfall far outstrips that which was evident in America’s only other jobless recovery — the upturn following the recession of 1990–91. In that instance, it took about 12 months for the job machine to kick back into gear. By our calculations, the current job profile in the private economy is now 2.4 million workers below the trajectory of the jobless recovery a decade ago.

Corporations have cut costs and restored profits during the recovery - so much so that their profits as a percentage of National Income are at boom-time highs. Corporate profits were 11.5% of National Income in the third quarter of 2003, up from 8% at the bottom of the recession (3rd quarter 2001). Corporate profits were just 9.6% of National Income at the peak of GDP (1st quarter 2000), they were 12.1% of income at their peak during the last boom (3rd quarter 1997) and they were just 9.8% of income at the peak of the Reagan/Bush boom (4th quarter 1988).

One really has to go back to the 1950s to see corporations taking such a large share of the income pie, or wage income taking such a small share. The ratio of employee compensation to corporate profits was below 5-1 for most of the 1950s. In the first quarter 2000 this ratio was 6.8-1. In the latest quarter the ratio is 5.5-1.

Given this, we can almost say that the recovery has largely run its course in terms of corporate profits, especially since we're seeing a good measure of public revulsion toward corporate greed that always accompanies this type of economic development. That leaves two modes of adjustment: either wages need to significantly increase, which would seem to require an uptick in employment not currently forecast, or consumers are going to run out of credit cards to max. Another alternative would be that the Bush Administration would refocus its budget priorities to support the welfare of those such as the uninsured and the unemployed, but that prospect is so laughable that I can barely believe I bothered to write it down.

posted by Teddy | 9:49 AM |