300 Million Americans. This Is The Best We Can Do?

I'm a little late to the party with this one. The clip is from last April, but I just saw it. I can't stop laughing. To remind readers, I am an independent (with a strong Libertarian bent) when it comes to politics, and I view both of the major parties and what they've done to our country with equal distaste, so this isn't an attack on Democrats (or it's an attack on Democrats and Republicans).

How does someone become U.S. Senate Majority Leader when he doesn't understand the basics of our tax system? This is the knowledge level of the people who are spending us into oblivion. I almost started feeling sorry for Harry. Almost.





Link to YouTube Video

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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.

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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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.

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.

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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.

The Money Hole

At least it might provide some support to gasoline prices...

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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.

The Ugly Step-Mother Of All Bailouts

In less than a week, we've gone from U.S. Treasury Secretary Paulson being "adamant" that no government money be used to bail out Lehman to an $85 billion bailout of AIG to a rumored $800 billion bailout of the financial industry and a new guaranty program for U.S. money-market funds. On top of that, the SEC is banning the shorting of 799 financial stocks.

All I'm reading is praise for these moves from all corners. Has everyone gone mad? This is a sad day in this country. Taxpayer money on a huge scale will once again be used to rescue failed private businesses, the bar for "too big to fail" is being significantly lowered, and moral hazard is again being trampled on. The "communist" Chinese must be doubled over laughing at us "capitalist" Americans.

I'll save my capitalism and regulation rants for other posts. For now, let's focus on this new government plan to buy distressed securities from financial institutions. First, we need to ask why the banks aren't selling these assets to raise capital. Paulson contends that they want to sell them but can't because there aren't any buyers. That's why the government "needs" to step in as the buyer of last resort. Well, Merrill Lynch was able to offload $31 billion of these securities at what really worked out to about 5 1/2 cents on the dollar. We also know that a number of funds have raised a significant amount of money to invest in distressed debt.

So, is the issue really that the banks can't sell the securities? Perhaps it's more intellectually honest to say that the banks could sell the securities, but if they sold them at a true market price, they would end up taking huge write-offs and would be technically insolvent. If this is the case, the only way the government will be able to help these financial institutions is by buying the securities from them at significantly above market value prices. Great deal for management and the shareholders. Not such a great deal for the U.S. taxpayer.

By the way, who is going to value the securities? The Wall Street financial whiz kids don't know what they're worth. Are we seriously supposed to believe that some government bureaucrats have the answer? I imagine they'll hire some Wall Street firms to tell them how much to offer for the toxic securities owned by the Wall Street firms!

I'm sure we'll hear how the taxpayers could actually make money on this deal, and that's certainly possible if the markets settle down, housing rebounds, employment rises, foreclosures stop, wages increase, and we're able to find some greater fool of a government to sell the securities to. Unfortunately, there isn't likely to be much upside for the taxpayer. If the government offers to buy these securities at true market prices, then very few banks will likely participate, and the bailout is irrelevant. On the other hand, if the government offers to buy the securities at above market prices there will likely be many takers, with the risk being transferred to the U.S. taxpayer who will be starting out this investment already under water (think load mutual fund).

So, the markets are rallying again on news of yet another government bailout. Everyone feels good. Just remember, if you're trying to figure out who the patsy is, and you still don't know after a few minutes, then you (Mr. Taxpayer) are the patsy.

We were fortunate to have reduced a good portion of our short position earlier this week following Wednesday's decline. We're once again gradually adding to our shorts on this rally.

Disclosure: The Rubbernecker is long shorting and short longing.

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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.

Death, Taxes, and A Ridiculous Employment Report

I’m finally getting around to reviewing the latest monthly employment report. I would have tackled it sooner, but I don’t type well when I’m rolling on the floor laughing and coffee is coming out of my nose. Now that my sides have stopped hurting and my nose isn’t burning, let’s take a look at the report.

To recap, the market was looking for a loss of 80,000 jobs in April, and the “official” number came in much better at a loss of only 20,000. The media pretty much universally applauded the report with headlines such as:

“US Stocks Rally on Jobs Report” – International Herald Tribune

“Jobs: Glimmer of Good News in April” – BusinessWeek

“Fur Seal Caught Trying to Have Sex With Penguin” – FoxNews

“Stocks Seeing Strong Gains On Employment Report” – RTT News

“Job Loss Far Below Expectations” – TheStreet.com

This employment report reminded me of the recent Google and Intel quarterly earnings reports. If you keep bringing down the estimates prior to the report to a level that’s easy to beat, you look like a hero when your report is just bad instead of apocalyptic. The purported loss of 20,000 jobs should look very suspect to anyone willing to pop an extra Ritalin, take a few minutes, and look beyond the headlines (this rules out most portfolio managers, government employees, and the breathing).

To really understand the employment numbers we have to look at what the Bureau of Labor Statistics (BLS) calls its Birth/Death model. According to the BLS,

There is an unavoidable lag between an establishment opening for business and its appearing on the sample frame and being available for sampling. Because new firm births generate a portion of employment growth each month, non-sampling methods must be used to estimate this growth.

What’s going on here? Basically, the BLS samples businesses and government agencies for its employment report. These sampled entities account for about 1/3 of all nonfarm payroll jobs. The BLS should be able to accurately measure the change in employment for those firms that remain in the sample from one month to the next. After coming in late for work on one of his 27 annual non-holiday work days, catching up on the latest Hollywood gossip online, and taking a lunch break that would make even the Italians blush, your average government employee can still probably muster up the simple arithmetic needed for this calculation. The picture is a little fuzzier for those firms that die (go out of business) since some of them may be too busy hocking their nail guns and backhoes at the local pawn shop to respond to the survey, and others will have already fired everyone, including whoever was responsible for reporting their data to the BLS. The final factor is the birth of new firms. This one isn’t directly measurable in any given month since it takes about 7 months before a newly spawned firm is available for sampling.

So, the BLS created a statistical model to estimate the net employment effect of the recently deceased and the newly hatched. Unfortunately, their model doesn’t appear to be very effective at times when a significant change in trend is occurring. This is hardly surprising. They’re no better than any other government agency, circus monkey, Federal Reserve chairman, or economist at knowing when a recession is underway (no offense to the monkey), so we shouldn’t expect their model to accurately account for this. So there’s a lag between what the birth/death model calculates and what’s happening in the real world at significant turning points in economic activity. When we’re headed into a recession, the model is spitting out fairy tale numbers based on much more robust historical comparisons while real jobs are disappearing. When the economy is turning up and creating more jobs, the model is finally reflecting the preceding deterioration and predicting fewer birthed businesses. Interestingly, they used to admit to this shortcoming on their website but no longer do.

With that background let’s turn to the most recent employment data. According to the bullish BLS report, the economy only lost 20,000 jobs last month. Virtually everyone in the media focused on this figure (including the experts dropped off at CNBC daycare). What they should have been discussing (had they been aware of it) is that this figure includes 267,000 jobs assumed to have been created by the birth/death model! Unless Obama infiltrated the BLS with his cronies who secretly adjusted the numbers for his 7 new states, this number is ridiculous. Ignoring those assumed jobs, the economy would have registered a loss of 287,000 jobs. Can you imagine how the market would have reacted to that headline?!

So, GDP is flat-lining, the financial and retail industries are suffering, manufacturing remains a basket case, and housing is in freefall, but somehow this model assumes that new businesses created 267,000 jobs last month. It stretches the limits of one’s imagination. Where exactly is this job growth? Not everyone can be a repo man, auctioneer, or Wal-Mart greeter. The model tells us that 72,000 jobs were added in the “Professional & Business Services” category. Maybe all of those ex-Realtors and mortgage brokers have reinvented themselves as credit repair specialists. 83,000 jobs were supposedly created in “Leisure and Hospitality”. I guess it’s possible if they’re counting all the new stay-at-home Dads. 8,000 new “Financial” jobs were supposedly created despite the carnage in banking. Maybe they recategorized all of the lawyers now lining up to sue the banks?

I saved the best category for last. The model assumes that 45,000 jobs were created in April in the construction industry. The construction industry! Seriously, why are we paying these folks? Why do we have or need a BLS if this is the quality of their work? How do they explain this? We all know that the construction firms are going out of business and laying people off. Residential building is screeching to a halt and commercial is now being impacted as well. I suppose all of those people who were fired from their construction jobs turned right around and started their own construction businesses to take advantage of all the business the firm that fired them didn’t have. Before hocking his nail gun I think our pawn shop friend used it to put the last nail in the coffin of common sense.

Here’s another point I love. The actual full release of the employment report runs to 28 pages. Guess how many of those pages make mention of the 267,000 birth boost? Zero. There is a reference to the existence of the birth/death model in the “Frequently Asked Questions” and the “Reliability of the Estimates” sections, but if you want to actually find the number you have to go to a separate web page (http://www.bls.gov/web/cesbd.htm).

Furthermore, we all know that the employment figures are often significantly revised. The birth/death figures are no different. So, why does anyone pay attention to these releases, and why does the market move on this “news”? First of all, most participants don’t take the time to delve into the details of these reports. As I mentioned, the BLS doesn’t even provide the birth/death figures in its 28-page release. Second, even if you know these numbers are inaccurate at best, if you think that the rest of the market is going to pay attention and trade off of them then you need to be interested in them, too. In this case, if Trader Timmy is going to jump off a bridge, you’d better at least go and dangle your toes off the edge.

As for the BLS statistical methodology, I’m not one to rush to judgment. In the interest of fairness, I decided to use their random sampling methodology on the BLS itself. The results were as expected. I just came up with the B and the S.

Hillary and John vs. The Economists

Hillary Clinton was on "This Week With George Stephanopoulos" yesterday and was asked about her gas-tax proposal. She is calling for the 18.4 cent per gallon tax to be paid by the oil companies this summer instead of the consumer, claiming this would save the average American an eye-popping $70 (McCain favors eliminating the tax entirely for the summer).

The biggest problem with this proposal, however, is that it assumes the price of gas will fall by 18.4 cents per gallon. Refineries aren't exactly holding back production. They're operating at effectively full capacity so supply is what it is. Demand isn't likely to fall during the summer driving season.

The price of gas is where it is because that's how much consumers are willing to pay for the given supply. So, there really isn't any reason to believe that gas prices would fall at all with Clinton's proposal. If we're willing to pay $3.69 per gallon right now, we'll be willing to pay $3.69 per gallon if the gas tax is "removed". Basic supply and demand.

Clinton isn't stupid, and she isn't surrounding herself with stupid people. She must know that there is no economic justification to her proposal. Unfortunately, she's simply pandering for votes.

Here's a part of yesterday's exchange with George:

STEPHANOPOULOS: Economists say that's not going to happen. They say this is going to go straight into the profits of the oil companies. They're not going to actually lower their prices. And the two top leaders in the House are against it. Nearly every editorial board and economist in the country has come out against it. Even a supporter of yours, Paul Krugman of The New York Times, calls it pointless and disappointing.

Can you name one economist, a credible economist who supports the suspension?

CLINTON: Well, you know, George, I think we've been for the last seven years seeing a tremendous amount of government power and elite opinion basically behind policies that haven't worked well for the middle class and hard-working Americans. From the moment I started this campaign, I've said that I am absolutely determined that we're going to reverse the trends that have been going on in our government and in our political system, because what I have seen is that the rich have gotten richer. A vast majority -- I think something like 90 percent -- of the wealth gains over the last seven years have gone to the top 10 percent of wage earners in America.

STEPHANOPOULOS: But can you name an economist who thinks this makes sense?

CLINTON: Well, I'll tell you what, I'm not going to put my lot in with economists, because I know if we get it right, if we actually did it right, if we had a president who used all the tools of the presidency, we would design it in such a way that it would be implemented effectively.

Whoa. Ok. So, she isn't going to put her lot in with economists. Now, I'm not one to rush to the defense of economists too often, so I won't do it here either. But let's look at a few of the folks who she does "put her lot in with".

First of all, there's Sandy Berger who was disbarred and pled guilty to stealing documents from the National Archive and then lying to the feds about it. Next, we have Roger Altman who served as the Deputy Secretary of the US Treasury, before resigning in 1994 because of a record-keeping scandal. Her recently-resigned Chief Strategist was Mark Penn who is a pollster.

I'm glad I'm not an economist! Hillary would clearly rather take the advice of the disbarred and the disgraced. As for pollsters, at least the economists offer their own opinion. Ouch.

Fedspeak for the Common Man

As expected, the Fed lowered the fed funds rate another 25 bps today (1/4%). I thought I'd take a few minutes to help interpret their accompanying press release.

"Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further."

translation: The economy is in the crapper. No one feels like spending money in this environment which makes sense since you're about to lose your job.

"Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters."

translation: We know better than anyone what shape the financial markets are in, and we can't believe you clowns are bidding up the stock market and financial sector! We're actually making side bets as to which of you hedge funds disappears next. Anyways, enjoy last quarter's snappy .60% GDP growth!

"Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months."

translation: Stagflation! I never should've left my teaching job at Princeton.

"The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization."

translation: Well, by The Committee I really mean all of us except the two dissenters who actually understand the role of the Federal Reserve, but they don't really count. Ignoring that, we've basically taken to good intentioning when it comes to slowing down inflation despite the fact that we keep lowering interest rates (tee hee). But don't forget the good news! With the economy slowing down that should help reduce demand for commodities! Hmmmmm....but that would mean the economy would have to be weaker....which would mean another rate cut....and a higher money supply....which has been pushing up commodity prices..... Frig'n Greenspan.

"Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully."

translation: Let me be perfectly clear. Inflation is a problem, but it isn't a problem, but it might slow down, but it might not. We feel very strongly that inflation will either be a problem or it won't.

"The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."

translation: Hey, Plosser! Push on my back. I can't reach my ankles.

UPS and Downs

UPS is the world's largest package delivery company, so their business results are certainly reflective of economic activity. The company reported first quarter earnings this morning. They met earnings expectations this quarter but lowered guidance for the balance of the year.

The falling dollar is helping their export business, but it's clear from their earnings release and conference call that they see no signs of an economic rebound. Specifically, management commented on how quickly volume fell off in February and the negative impact of rising fuel costs.

Here are a few snippets from the earnings release:

A sharp decline in U.S. economic activity, however, led to a 9.4% drop in diluted earnings per share to $0.87 compared to a prior-year adjusted $0.96.

...consolidated average daily volume remained flat at 15.1 million packages per day.

"U.S. economic activity deteriorated more rapidly than expected during the quarter," said Scott Davis, UPS chairman and CEO.

The slowing U.S. economy not only reduced average daily volume in the U.S. by 0.3% for the quarter but also contributed to a shift away from premium products.Volume declined 3.8% for Next Day Air(R) and 2.9% for Deferred, while increasing 0.3% for Ground.

"We see no signs of economic strengthening in the second quarter," said Kurt Kuehn, UPS's chief financial officer.

Export volume increased approximately 10% in local operating days, which drove a 15.7% revenue increase.

Housing Starts fall 11.9% in March

According to today's Census Bureau release:

Privately-owned housing starts in March were at a seasonally adjusted annual rate of 947,000. This is 11.9 percent (±11.6%) below the revised February estimate of 1,075,000 and is 36.5 percent (±5.2%) below the revised March 2007 rate of 1,491,000.

Single-family housing starts in March were at a rate of 680,000; this is 5.7 percent (±11.1%)* below the February figure of 721,000. The March rate for units in buildings with five units or more was 247,000.

The headline is pretty ugly. 11.9% fall in March. The chart above is even uglier. The total housing starts series goes back to 1959. The highest monthly figure is 1,837,000 starts in January 2006. That number has declined 63% to the current run rate of 680,000 annual housing starts.

The lowest figure since 1959 was 523,000 and that occurred in October of 1981 as Volcker was busy jacking up interest rates well into the teens to combat inflation. We're not all that far from a new record low.

This is actually good news. We have a huge oversupply of housing currently, and the only way to stabilize the housing market is to lower supply and/or increase demand. Lower housing starts helps to lower supply. With demand still weakening this isn't going to be fixed overnight, but the housing market is adjusting as it should. I expect this to take longer to correct than most and continue to be net short this sector.

Youngstown, Ohio is doing its part to speed the correction. Link to article.

Stiglitz and the Charmin Prescription

Recession Watch - Consumer Sentiment

The latest reading of the University of Michigan Consumer Sentiment Index is the lowest we've seen since the early 80's when inflation was soaring and Volcker was busy jacking up the Fed funds rate to 19%.

At least Bernanke is now talking about the chance of a recession. The talking heads are almost always behind the curve. The issue isn't whether we're in a recession but rather how long and deep it will be.

The only reason there's been any debate at all as to whether we've been in a recession is because of the manipulation of inflation statistics by the government. The real GDP figures reported by the government are overstated due to their ridiculously low calculation of inflation. The lower the inflation figure, the higher the reported real GDP.

Consumption accounts for about 70% of U.S. economic activity, and the U.S. consumer is clearly in retrenchment mode. I expect this recession will be longer and/or deeper than the consensus view. Therefore, it's likely still too early to bottom fish in the consumer discretionary sector.