A collection of today’s economic, market, political, geo-political, and human interest news, thoughts, and analysis.
In This Month’s edition:
- Trickle Down Economics
- How the Next Financial Crisis Will Happen
- The Allocation Stairway
- Why the Economy Limps Along
- Random Thoughts
Trickle Down Economics
Any student of economic theory can easily grasp the concept of free market capitalism where the power of entrepreneurial pursuits plant the seeds for industrial development which in turn builds companies, which in turn builds industries, which in turn creates jobs, which in turn creates the demand for goods and services, which in turn creates more jobs, which in turns creates the most economic good for the most people. (Deep breath).
Any student of politics has witnessed the attempt by the left to invalidate the concept of trickle-down economics which was successfully introduced by Ronald Reagan and is a firm cornerstone of the success behind Reaganomics. In reality, over her brief history, America has seen various periods of what defined Reaganomics. Unfortunately, every time we have gone through those times of prosperity, our government finds a way to spend it and further regulate future opportunities away. Ever since Reagan’s success, the left has been consumed with their goal of destroying this common sense approach by distorting and misrepresenting the theory for their own advantage mostly by claiming that only the rich benefit. That is until Obama went to prison.
In his own attempt to define deviancy down (see last month’s piece on The Economics of Social Decay), he became the first American president to visit a federal prison. During a speech in El Reno, Oklahoma he chastised what he believed to be an unfair legal system, and at the same time threw out his support of trickle-down economics…probably unwittingly so but support none the less.
While referring to the importance of education, he said, “When we make those commitments to all of our children, the great thing about it is the blessings are returned back to us because you end up having a workforce that is better educated, which means suddenly companies want to locate (there), which means business starts booming, which means businesses start hiring, which means everybody does better so not only is it the right thing to do but it’s the smart thing to do. That’s our tradition. It’s not Democrat or Republican. It is the American tradition, and we forget that sometimes because we’re so caught up in our day to day politics.” Anyone notice how I patterned my sentence structure and cadence in the opening paragraph after the above quote? If so, good for you.
In his quote, the president aptly described trickle-down economics and also identified the inefficiency of political rhetoric (both sides). It’s a shame that he doesn’t really believe it.
The free markets are the most efficient means of creating the most economic benefit for the most people. In order for it to work best, government has to get out of the way, but unfortunately it does the exact opposite. History has taught us time and time again that when you reduce taxes and regulation, you get higher levels of economic growth which not only provides more income for the greatest number of citizens but also creates more tax revenues for the income starved treasury.
The latest and best example of over-regulation was the Dodd-Frank bill that came out of the 2008 economic crisis and helped lead to the weakest recovery from a recession in modern history. An opinion piece in the WSJ took a look at the law five years after Dodd-Frank was passed and deemed it a failure claiming that the law has crushed small banks, restricted access to credit, and planted the seeds of financial instability. The Dodd-Frank law was the most sweeping reform of our nation’s financial laws since the New Deal. Obama told us the law would “lift our economy”, “end too big to fail” and “promote financial stability”. As with far too much in the way of political justification blah, blah, blah, none if it ever happens. Such is the case here.
The article reminds us that the faulty premise behind those who authored Dodd-Frank was that the financial crisis was the result of deregulation. In reality, regulatory restrictions on financial services actually had increased every year from 1999-2008. The deregulation argument doesn’t hold water. As the WSJ piece suggests, instead of deregulation being the problem, it was dumb regulation that set us on the path towards financial ruin.
The genesis of the 2008 credit crisis found its roots in 1977 when Washington began forcing affordable-housing mandates. Another wonderful, well intentioned goal that fails under the weight of unintended consequences. Banks were forced to make loans to people who could not afford them and were bad credit risks. Wall Street, aided by federal ratings agencies, created financial instruments that absorbed these loans into income generating securities allowing banks to move these risky loans off their balance sheets.
This only worked as long as housing prices continued to rise reducing the debt ratios as a result. When the economy cycled into a slowdown period and home prices ceased their irrational rate of increase, home prices began to fall, these loans began to fail, and the weight of them began a spiral that almost brought down our entire financial system. It started with our government over-regulating and ended in the very people that created the problem trying to fix it with even more regulation in the form of Dodd-Frank…regulation that we are now finding is strangling economic growth and recovery
Politicians are particularly adept at redirecting blame as was the case with Dodd-Frank. They weren’t going to blame themselves and found a scapegoat in Wall Street who, by the way, was certainly not blameless. Wall Street may have aided and abetted but was hardly the principal offender.
So far, it appears that too-big-to-fail institutions are even more so, there are fewer smaller, community oriented banks, and the financial system is arguably less stable. So, let’s take a look at the impact this law has had on our economy:
- Wall Street was targeted, but it was Main Street that got clipped. Community financial institutions which were the source of most small business loans were collapsing under the complexity of the law. They are closing at a rate of one per day.
- 75% of banks offered free checking pre-Dodd-Frank. Two years after it was only 39%.
- According to the Dodd-Frank Financial Stability Oversight Council, many of the threats to financial stability are a direct result of the law itself as well as are other policy actions.
- The ban on proprietary trading by banks has drastically reduced the liquidity necessary for efficient management of all fixed-income assets. The corporate bond market is one of the primary means of capital formation in our economy and reduced liquidity increases volatility which means more risk. The resulting risk/reward ratio makes this form of investment diversification less attractive and less effective.
- The over-regulation of derivatives focuses systematic risk on the clearing houses making them too big to fail which is another way of saying that it’s the taxpayer on the hook.
- Bank holding companies must file detailed plans stating how they will weather future financial crises. Regulators have the ability to force these holding companies to restructure, raise capital, divest or downsize which opens the door to political misuse of power and even greater unintended consequences.
- Probably the scariest aspect of all is that the government now has the ability to control huge portions of our broad economy through their oversight privileges.
In keeping with Nancy Pelosi’s famous quote on ACA, “we have to pass the bill so that you can find out what is in it…” Dodd-Frank’s co-author, former Senator Chris Dodd, actually said, “no one will know until this is actually in place how it works.” Well, today we know and it should be scrapped. As absurd as it seems, these people are actually running our country. Texas U.S. Representative Jeb Hensarling (Chairman of the House Financial Services Committee) summarized the Dodd-Frank law as “turning America’s largest financial institutions into functional utilities and taking the power to allocate capital – the lifeblood of the U.S. economy – away from the free market and delivering it to political actors in Washington.” Percolate on that a little bit.
So, there you have it. However, many politicians are trying to convince the voters that the economy is strong and growing nicely while they scratch their heads in private as to why growth is barely visible. The answer is right in front of them, but they either can’t see it or refuse to admit it. Is there any wonder why candidates like Donald Trump are doing so well? People are fed up with Washington incompetency. It would seem that the “You’re Fired” mentality will continue to rule election outcome as voters voice their displeasure at the polls. I, for one, couldn’t be happier.
How the Next Financial Crisis Will Happen (WSJ 6-10)
(Stephen Schwartzman – Chairman, CEO, and co-founder of Blackstone)
I frequently will tell people that the next market meltdown is not a matter of if but of when. The reality is that no one knows when major corrections will occur, what combination of events will conspire as the cause, or how severe the temper tantrum might be. All history has taught us is that it will most assuredly happen again and we will all be surprised in a major way. The surprise may be from the timing (generally when it’s least expected) or the cause (probably for reasons few have considered) or a more likely combination of the two.
This unknown certainty always fails to disuade very smart people from making bold prognostications of why and/or when the next collapse will happen. Such is the case with Stephen Schwartzman. It is his belief that the ‘expansive and untested regulatory framework devised by politicians and regulators following the 2008 financial crisis (Dodd-Frank’s Capital Liquidity Rules) will lead to unintended consequences related to the liquidity in our financial system. These unintended consquences will lead to a liquidity vacuum where there are no buyers and prices plummet as a result. We are currently seeing this effect in real time. The fall becomes a self-fulfilling prophesy as firesales lead to firestorms.
This will result in banks being forced to sell off assets and hoard liquidity to meet federal regulatory requirements. Companies will be unable to raise capital, the economy will contract with heavy layoffs resulting in lower tax revenues and a severe squeeze on middle and lower class Americans. In this type of financial crisis, only the Fed stands in the way of collapse as the lender of last resort. However, some legislators have proposed further limiting the Federal Reserve’s emergency lending powers. Has government and those powerful regulators who answer to no one swung the pendulum too far in the other direction? I guess we’ll see.
The Allocation Stairway
We employ the wisdom and allocation modeling created by Stairway Partners within our Global All Cap Balanced strategy. The core principles of this strategy are built on the foundation of Modern Portfolio Theory (MPT) and the principles of asset allocation. Stairway came out of Brinson Partners…one of the largest and most successful asset allocation and asset management firms in the world before they were sold. Stairway’s earnings based modeling has proven to accurately predict future earnings by asset class. As we all know, earnings is the primary determinate of asset pricing.
Based on those predictive modeling techniques, allocations are built that appropriately over and underweight the primary asset classes accordingly. Their proven track record has consistently been ahead of major turning points. While sometimes early, they are almost always accurate.
Their most recent research suggests that earnings, and by extension, price growth will be negative for the next three years for domestic equities and fixed income. Accordingly, they continue to maintain a reduced weighting to these asset classes. Their models suggest that earnings for the emerging markets and Europe will be positive for the next three years.
About a year ago, they began over weighting both emerging markets and Europe. While that decision has proven a bit early, they are standing by that conviction and maintaining the over weights in those spaces.
Our Global All Cap Balanced strategy has three different risk allocations and serves as our primary exposure to what we define as BETA investing…relative return expectations that will be directionally influenced by movement within the equities and fixed income markets.
Philosophically, we believe that diversifying your risk is far more important than diversifying your assets. To that end, we employ two other risk buckets to compliment BETA. We call them ALPHA and DEFINED RISK. The goal of our ALPHA risk bucket is absolute return generating a positive annual return regardless of what the markets do. Our DEFINED RISK strategy invests primarily in equities but defines the risk of each position in absolute, quantifiable terms. This three legged stool effectively builds a far more diversified allocation than tradition MPT approaches could ever achieve. Our overall goal is to create a high return on the amount of risk an investor is willing to take. If you want to learn more about any of these, please give me a call.
Why the Recovery Still Limps Along (WSJ 6-23)
(Edward Lazear – former chairman of the Council of Economic Advisors, professor at Stanford University’s Graduate School of Business, Hoover Institute Fellow)
One of the greatest think tanks the world has ever seen is the collective power of 50 idea incubators that make up our United States. Each state tends to have their own unique sets of problems, resources and opportunites. Solutions designed at the local level tend to be the most efficient for each of these slices of what makes up the United States of America. However, the major issues facing us all tend to know no borders. These national issues might best be resolved by unleashing the individual braintrusts in each state to come up with the right solution. The best of those solutions can then be modeled for the national good. The painfully slow recovery from the Great Recession has provided the perfect test case for just such a plan.
As Edward Lazear points out in his recent Wall Street Journal piece, “…cross state comparisons provide a real world experiment that helps show which economic policies work and which don’t.” Using employment, state GDP, labor-law, and tax data for the last 15 years, he was able to demonstrate how policy matters in determining the most effective and most broadly reaching economic outcomes.
The conclusion was crystal clear that those states exhibiting a business friendly climate as defined by their labor, regulatory, and tax policies achieved far better GDP and employment growth than those that didn’t. In general, right-to-work states that had minimum wage levels at or below the national average saw employment growth twice that of states where union members are forced to pay dues and the minimum wage was above the mean.
The five fastest growing states were Nevada, Utah, Texas, Arizona, and North Dakota. All five had business friendly labor policies and four of the five have tax rates that are below average. The poorest peforming states were Michigan, West Virginia, Mississippi, Illinois and Ohio. Four out of those five states did not have business friendly policies and had above average tax rates.
If you really want to find the most efficient way to improve the quality of education or healthcare, give states the freedom to create their own solutions and take it away from federal bureaucracies. A great example of this is land management. Nearly half of the U.S. land mass west of the Mississippi is owned by the federal government…most are not national parks or wilderness areas and are rich in resources.
Individual states control the balance of what is not privately owned. Western states are beginning to question the effectiveness of the federal government managing these lands and are beginning to want them back. These lands are ripe for many uses including logging, grazing, energy and recreation. Apparently the feds can learn lessons from the states on efficient land management policies.
The Forest Service and the Bureau of Land Management loses $2 billion per year managing federal lands. States consistently generate positive returns on the lands they manage. Arizona, Idaho, New Mexico, and Montana earn an average of $14.51 for every dollar spent on land management. Conversely, the federal government loses $0.27. Studies show that these states earn on average of 7 times more for every dollar spent on timber and energy development, 35 times more on grazing, and 25 times more on recreation. In New Mexico alone this amounts to $817 million which is enough to pay for 17,000 public school teachers (source: New Mexico land office). The states are doing this without causing more harm to forest health or water resources. Like so many other inefficient federal programs, we would all be better off responsibility were ceded to the appropriate states thus removing federal control and oversight.
So called pro-growth politicans are nothing of the sort unless they push for lower taxes, less regulation, and greater state’s rights. Without all three, you get mediocrity and unintended consequences that serve as a head wind to growth and economic equality.
In another example of how mainstream media steals the narrative of a tragic story and turns it into one that neatly fits into their biased agenda, we have another tragic story of misguided journalism. For those who might like to deflect this as a pro-gun stance, it’s not about guns. It is about the general failure of journalism to do its job. So what am I talking about? On August 26th, a disgruntled, probably mentally unstable former worker murdered a bright, young, beautiful reporter and her cameraman using a handgun. The story had barely reached the airwaves when the anti-gun crowd aided by the mainstream media began the gun control drum beat. In this case we had a gay, African American male who killed a white reporter and the narrative immediately became about guns. Can you imagine what the narrative would have been had the roles been reversed. Imagine the outrage had it been a disgruntled white person who gunned down a gay, African American reporter. In that case, I would presume, the headlines would have had a homophobic, racism and hate crime theme; and guns would have been a mere afterthought. The shame is that in either case the real problem fails to receive the attention it should. Like in so many other instances, we try to cure the politically expedient symptom and fail to address the disease. In this case the disease is mental illness, but that doesn’t fit nicely into the progressive agenda.
Are you like me in that I automatically assumed that simply by being born in the United States, no matter what the citizenship or status is of the birth parents, the baby is granted U.S. citizenship? At least, that’s what we have been led to believe. Well isn’t it interesting that the 14th Amendment says nothing about birthright citizenship. Nowhere does it state that a baby born to ILLEGAL immigrants is automatically a citizen of the United States of America. The 14th Amendment gives power to Congress in Article 1.4.8 where it states that “Congress shall have power to establish a uniform rule of naturalization.” In other words, Congress determines who can and cannot become citizens of the United States…not the Constitution. Lastly, contrary to what many would have you believe, the Supreme Court has never opined on whether children born in the U.S. to illegal immigrants are automatically citizens of the United States. The courts have only ruled that the children of legal immigrants born in the United States be granted citizenship. Technically millions of babies have arguably been wrongfully granted citizenship because we have simply not paid attention.
Recent Fox News Polls show some fascinating numbers with three of the top five Republican candidates never having held elected office. In fact, recent polls have found the 42%-45% of those asked seem to prefer someone with no political experience. Personally, I find this as an encouraging signal that Americans are ready to take their country back. The silent majority is finally rising up and voicing their displeasure with how things are done in Washington. I guess if you have been paying attention during the last two election cycles, this trend has been building. Americans are responding to candidates that are not politicians. As a result, this primary stands to be very different and should be a lot of fun.
In the latest example of how America fails to learn from history and is thus doomed to repeat it, Obama’s nuclear deal with Iran essentially assures that Iran will build deliverable weapons technology in the very near future. One of Bill Clinton’s legacy achievements was a nuclear deal with North Korea. In 1994, Clinton did a victory dance as he defended his agreement to give North Korea oil, nuclear energy technology and sanctions relief in return for the North Korean government to cease development of nuclear weapons. All North Korea did was bank all the concessions and then used them to race ahead and become a hostile nuclear threat. Clinton left office claiming victory as the rest of us watched how hollow the agreement actually was in reality. The Obama administration’s recent victory dance is eerily reminiscent. In a veiled attempt to create another legacy building block of questionable value, the recent nuclear deal paves the way for Iran to become the world’s next nuclear power whose motivations are to ultimately destroy Israel and America. How is it that the world’s greatest defender of freedom keeps making the same mistake over and over again where we trust an agreement with a sworn enemy whose moral and ethical makeup is nonexistent? Shame on us.
There are lots of ways to explain how government works. The following anecdote does a pretty good job of creating a fictional example that explains a lot:
Once upon a time the government had a vast scrap yard in the middle of a desert. Congress feared that someone might steal from it, so they created a night watchman position and hired a person for the job. Then Congress wondered how he could do his job without some sort of direction, so they created a Planning Department and hired two people. One wrote the instructions and the other did time and efficiency studies. Then Congress wondered how they would know if he was doing his tasks correctly, so they created a Quality Control Department and hired two more people…one to do the studies and the other to write the reports. About then Congress began to wonder how all these people would get paid, so they hired two more people to keep track of hours worked and the other to act as the payroll officer. Then the bureaucrats asked themselves who would supervise all these people, so they created an Administrative Department and hired an Administrative Officer, Assistant Administrative Officer, and a Legal Secretary. At last the President realized after they had this structure over a year and were $18,000 over budget. He ordered the bureaucrats to cut back. So, they fired the night watchman. So now you know how government works. Thanks to Steve Straub for this little ditty.
With fashions, never throw anything out. If you wait long enough, everything will come back into style. The same seems to be true with climatologists. In the 1970s, those of my generation may recall that we were on the verge of the next ice age. Global cooling gave way to global warming which in turn gave way to climate change (like no one knew that climates change) which has now apparently gone full circle back to warning about how the world may be cooling. European scientists led by North Umbria University professor Valentina Zharkova now projects that the Earth will suffer through a mini ice age within 15 years. Zharkova claims that his model is 97% accurate. Like financial models, they are all perfect. The problems occur with what assumptions you use inside the model. You know…garbage in garbage out. I won’t bore you with the facts since they generally are a bunch of nonsense at both extremes. It’s kind of like trying to predict what the stock market is going to do. You can’t, but as soon as you are sure you’ve got it figured out, it does the opposite. In the meantime, we waste incredible amounts of money, lost progress, brain power, and emotional conflict. Most of what happens is totally out of our hands, so let’s focus on making sensible changes to what we can control with practical solutions and play nice. Wouldn’t it be a nice change if common sense ruled the day.
Hillary’s climb to the nomination summit seems to be much more challenging than her stated namesake’s (Sir Edmond Hillary) ascent to the top of Everest. As each day passes, it seems less and less likely that Clinton’s previously assumed ordination will actually occur. It could very well be that a court of law will define her future far more definitively than the court of public opinion. It will be interesting to see who picks up the baton that is slipping from her fingers.
The Donald is probably the most disliked candidate in the vast Republican field. Interestingly enough, he is also the most liked and seems to be winning people over with his unorthodox approach to campaigning. I don’t know about you, but every time I hear him speak, he makes me laugh. While I’m not sure that he has a clue about how to get the things he proposes done, it sure is entertaining to listen to him talk about what he would do if elected. His contempt for political correctness and courage to say things that have long needed to be said are oddly refreshing and often compelling. As I predicted in my pre-pre-election commentary, we are finding more and more of his primary challengers adopting a similar approach. He is changing the dynamic…for the better in my opinion.
Congratulations to our favorite (and only) son Tom who married Abbie, the love of his life, on August 29th at a big, black tie event in Chicago. Abbie now enters our family as my favorite (and only) daughter-in-law. She joins Emily who is my favorite (and only) granddaughter and Emily’s father Scott who is my favorite (and only) son-in-law. Our two daughters and three grandsons will have to keep fighting to achieve favorite status which I can assure them that they will never achieve. Being that there is more than one of each, they will all have to share the status of favorite. As I wrote to Abbie’s father the next day, “We all set our own high hopes and goals for our children including with whom they eventually choose to spend their lives. It’s very rare that those hopes are exceeded in every way. We just experienced such an outcome. Now we turn to the next chapters which have yet to be written, but which I am confident will reveal themselves with similar results. This is a book that I’m sure none of us will ever be able to put down.” Sue and I couldn’t be more pleased.
The next 14 months should be pretty interesting in the economy, in the markets, and for politics. We will likely see things that we have never seen before. I, for one, am looking forward to it. Stay tuned.
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