Friday, January 30, 2009

Q4 GDP - Real GDP vs. Final Sales

I'm seeing plenty of headlines this morning highlighting how GDP supposedly came in much better than expected at down 3.8% (annualized) versus an expectation of down in the 5-5.5% range. As always, the devil is in the details.

Not too surprisingly, personal consumption and private investment both fell significantly, -3.5% and -12.3% respectively. The key figure in understanding the headline number, however, is the change in inventories. Real inventory growth in the quarter had the effect of adding 1.32 percentage points to real GDP. When we ignore this inventory build, we get a figure known as final sales. Final sales fell 5.1% in the quarter.

Inventory was reduced by $50.6 billion in the second quarter and $29.6 billion in the third quarter. Why did inventory grow in the fourth quarter? It can most likely be attributed to a weak holiday selling season combined with a little too much optimism. Retailers didn't sell as much as they hoped, so they ended the quarter sitting on extra inventory which left excess inventory at the wholesaler/manufacturer level.

Why is this important? If an inventory build occurs to prepare for future growth then there shouldn't be a problem. However, to the degree that any increase in inventory can not be met by demand, we are effectively borrowing production from a later period.

The bottom line is that an inventory build that isn't met by current demand will result in lower future GDP since production will need to be scaled back to reduce the excess inventory. It's kind of like getting an advance on your paycheck. Your income may have technically gone up today, but that "loan" has to be paid back. With the global economy clearly slowing further over the past month, this "better than expected" GDP report will likely lead to a weaker report next quarter -- at least weaker than it would have otherwise been.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Wednesday, January 28, 2009

The Output Gap II - Revenge Of The Anti-Keynesians

Here's a timely follow-up to yesterday's post, "The Output Gap." The Obama administration may be surprised to learn that not all economists are Keynesians. Not all economists believe that the right course of action is to throw unseemly amounts of borrowed or "printed" money around.

The Cato Institute is running an ad with the signatures of quite a few economists to combat the belief that everyone believes that fiscal stimulus is the correct path. It was nice to see a few names from my alma mater on the list. I also couldn't help but notice that, just like our friend Paul Kr_gm_n, there were a couple of individuals on the list who at one point shook hands with the King of Sweden.

Link to the ad

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Tuesday, January 27, 2009

The Output Gap

I don't want to single out any specific 2008 Nobel Prize-winning economist for criticism, so let's just call this anonymous person Paul Kr_gm_n. Paul, as we'll refer to him, has been busy of late blasting any economist who dares offer a critique of his recommendations or dares to provide an alternative solution to our economic ills. He hasn't been bashful. He's been critical of some of the most respected names in the profession. It seems that shaking hands with the King of Sweden (yes, Sweden has a King) instantly confers a sense of infallibility upon the shakee.

Paul belongs to an overwhelmingly large group of blathering wisenheimers known as Keynesians. Keynesians can be easily recognized due to the fact that they answer every question the same way. How do we get the economy moving again? "The government should spend more money." What do we do about insolvent banks? "The government should spend more money." What's the capital of Latvia? "The government should spend more money."

Keynesians are arguing that massive fiscal stimulus is needed to fight the current economic downturn. That's hardly surprising. That's what Keynesians do. That's what they've always done. They're the best shoppers in the world with the biggest credit card.

Let's focus on just one of the concepts that the Keynesians rely upon to justify their shopoholism-- the output gap. The output gap is a measure of the potential GDP of the country less actual GDP. In other words, it's a measure of the difference between actual economic output and potential economic output. Not to get too academic, but actual GDP consists of consumption, investment, government spending and net exports. During a recession, consumption and investment typically fall. Government spending, of course, never falls. The fall in consumption and investment lead to a drop in actual GDP to levels below potential GDP. Keynesians have a solution for this shortfall. "The government should spend more money."

Keynesian posterboy, Paul, recently summed up the current situation:

Bear in mind just how big the U.S. economy is. Given sufficient demand for its output, America would produce more than $30 trillion worth of goods and services over the next two years. But with both consumer spending and business investment plunging, a huge gap is opening up between what the U.S. economy can produce and what it's able to sell. And the Obama plan is nowhere near big enough to fill this "output gap."

Even the CBO says, however, that "economic output over the next two years will average 6.8 percent below its potential." This translates into $2.1 trillion of lost production. "Our economy could fall $1 trillion short of its full capacity," declared Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion - possibly a lot more, if the budget office projections turn out to be too optimistic - Obama offers a $775 billion plan. And that's not enough.

Paul is arguing that government spending should be increased by over $2 trillion over the next couple of years to make up for lost output, but shouldn't we be questioning whether recent levels of GDP are even defensible? Didn't we just experience a massive credit bubble? In recent years, both residential and nonresidential construction experienced a tremendous and unsustainable debt-driven boom. Consumption was pushed up to unsustainable levels in recent years with people racking up revolving debt and pulling equity out of their homes to buy plasma TVs, take vacations, and pay for a lifestyle they couldn't afford. This historic credit bubble most certainly goosed GDP in recent years. Is this really a level of GDP that we should be trying to support?

There is an analogy here between GDP and the financial system. We now all realize that the profits reported by the financial system between 2002-2007 were grossly overstated due to the fact that asset values were being overstated and loss reserves understated. Similarly, sustainable and productive GDP has been overstated in recent years as consumption and investment have been driven unsustainably higher through the use of massive amounts of nonproductive debt. It's madness to try and sustain this level of economic activity.

So, now GDP is likely to fall a couple of trillion dollars over the next couple of years. Great! It shouldn't have grown to this level in the first place. Yes. More plants and businesses will close, and more people will lose their jobs. That is unfortunate, but a sustainable level of demand doesn't currently exist to support these plants or jobs, and it would be fiscal madness to plug this gap indefinitely. The government should let the market clear away the excess. Trying to sustain economic activity at an unsustainable level and growth rate will just lead to larger levels of government debt, higher inflation (and/or higher levels of future taxation), lower future growth, and a less productive economy as government spending displaces the private sector. There is no free lunch.

If our economists and politicians want to focus on an output gap, I recommend they spend some time looking at the difference between the GDP forecasts of economists and actual GDP. Now that's a huge output gap.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Saturday, January 17, 2009

Some Comic Relief

Hat tip to CR!



The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Wednesday, January 14, 2009

"Sign" Of The Times

Thanks to Ryan for sending the following article about psychics and financial advice to me. For the record, I knew he was going to do that.

From the Daily Tar Heel: "Local psychics seeing more financial questions"

You can't beat the beginning of the article:

For Chapel Hill psychic Millie Wallace, business is booming.

As the economy worsens, more people line up to have their palms read and cards interpreted to anticipate their financial future. For some, the advice offered by stock brokers and investment bankers just isn’t cutting it anymore.

“We see things,” Wallace said. “Some accountants just guess at what kind of stock to invest in­, but people come to psychics because we know.”
The psychics know! Such conviction. If I made that kind of statement, I'd likely end up spending a good deal of time explaining my business practices to a bitter team of regulators looking for redemption for the Madoff miss. And which accountants are out there making stock recommendations? I always wondered who would go to a psychic for investment advice. Now I know -- anyone who had been getting stock-picking advice from an accountant.

Not to pick on Millie, but I'd love to know what she was invested in last year. She probably had her money tied up in crystal balls, tarot cards, incense, and scrying bowls. Ok. She would have beaten the market, but she probably just got lucky.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Geithner: 1040 Good Buddy

Tim Geithner is Obama's pick for Treasury Secretary. Tim has been the President of the Federal Reserve Bank of New York since 2003. Prior to that, Tim had worked at the Treasury Department. Tim also once worked at the International Monetary Fund. Tim can't figure out his own taxes.

This is just too precious. The man who has been working side by side with Paulson and Bernanke to "save" our financial system apparently wasn't aware that you have to pay your Medicare and Social Security taxes if you work for an employer that does not. The "discrepancy" arose during his time at the I.M.F.

According the the New York Times:

The I.M.F., as an international organization, does not withhold payroll taxes for Social Security and Medicare from its American employees’ paychecks. Those workers are required to pay the roughly 15 percent tax themselves, as if they were self-employed.

However, the I.M.F. does pay its American workers an amount equal to an employer’s half of the payroll taxes, with the expectation that they will use that to pay the I.R.S. The organization also gives them quarterly wage statements that include United States tax liabilities.

Mr. Geithner fully paid his state and federal income taxes. In failing to pay his payroll taxes, he in effect kept the money the I.M.F. had contributed toward his liability. However, Mr. Geithner’s accountant told him he was exempt from self-employment taxes, according to Obama transition officials.
To be fair, I am no fan of the U.S. tax code. It is ridiculously overburdening and complicated. Hire ten different accountants to do your taxes, and you'll get ten different answers. At the same time, I'm self-employed and have to pay my own Social Security and Medicare taxes. It's not that difficult. Tim could have shelled out less than $100 on TurboTax and got this right. The I.M.F. even gave him a quarterly statement that included this tax liability! Still, Mr. Geithner and his accountant (hopefully ex-accountant) thought that he was exempt for some reason. I hope there was better rationale than, "Hey, Tim. You're rich and powerful, so you don't have to pay that. Taxes are for losers."

Does anyone remember Zoe Baird? Bill Clinton nominated her for attorney general back in 1993, but she was shot down because she hired some illegal aliens and neglected to pay their social security taxes. Tim may not have hired any illegals (though someone should verify the status of his accountant), but the situation is pretty similar. This time, however, Congress is rushing to Tim's defense and proclaiming this matter is "a lot to do about nothing." This guy is up for Treasury Secretary! The IRS falls under the purview of the Treasury Department. The guy who will likely run the whole shebang doesn't know what taxes he owes or what constitues child care (see article). Poor Zoe was born 15 years too early.

I have a strong feeling our economy would be better off in the years to come if we just turned it over to TurboTax.

The full article can be read here.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Monday, January 12, 2009

Some Nice Local Press

Over the past couple of weeks, the Cary News, the Raleigh News&Observer, and WRAL each published/aired a story about my involvement in helping the town of Cary with its investment portfolio last year. I wasn’t looking for or expecting any acknowledgment, so the press coverage has been a pleasant surprise.

There are two factual points to clarify. First, although the article refers to my “gut feel”, my concerns came from a detailed analysis of Fannie and Freddie's balance sheet as well as my expectations for a deteriorating housing market. I leave hunches and inklings to more trivial matters like whether to have a baby or which wild berries to eat.

Second, the article and TV clip mention that I sold positions in Fannie and Freddie for myself and my clients. The fact is that I never owned these stocks. I actually shorted (bet that the share price would fall) Freddie Mac (FRE) shares back in March for myself and clients. The concept of shorting can be a little difficult to grasp, and I suspect the reporters were busy enough trying to figure out if there was any possible lighting scheme that would make me look remotely presentable.

The TV news segment was filmed with virtually no notice, so I'm grateful to the WRAL team for their generous and thoughtful editing. I have a new respect and understanding for just how quickly and efficiently a news crew is able to pull a story together and get it on the air. Of course, I'm also grateful to the town's finance department for taking my concerns seriously.

TV segment:

Newspaper article:

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Thursday, January 8, 2009

Fama On Bank Recapitalization

There were many factors to consider when choosing an MBA program, but the truth is that I settled on the University of Chicago because that's where I could study under Eugene Fama. The two classes I took with him have proven well worth the price of admission (I am not receiving a referral fee from the University).

Fama has recently started a blog (with his colleague Kenneth French) which is the latest addition to my must-read list. His most recent piece on bank recapitalization discusses the impact that various forms of equity injections have on the U.S. taxpayer and bank stakeholders. It's not the lightest read, but he makes some very good points.

Link to article

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Tuesday, January 6, 2009

Paul On Regulation And Ponzi Schemes

One of the very few congressmen who understands economics, monetary policy, fiat currency, regulation, inflation, and moral hazard. His point about the SEC is similar to that made here in my December 16th Madoff post:

As for the regulators, they clearly and spectacularly failed -- again. Unfortunately, this will lead to calls for broader and deeper regulation. Regulation fails? Then we must need more! I imagine a number of Madoff investors took some comfort in knowing that the SEC had investigated Madoff and signed off. Perhaps if the SEC didn't exist, investors would have spent a little more effort themselves looking into his operation. Alas, the SEC is likely to benefit from its amazing failure by being given even greater funding. Perhaps the defrauded investors will sue the SEC for negligence.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.