Leeds on Finance

You’re going to notice some changes in the blog during the next few months.  You will see shorter (hopefully more frequent?) blogs. I’m hoping to send out one interesting slide, idea or factoid each week (without the long summaries or commentaries).  The reason for this is that I’m in a very busy stretch – I’m writing a new class at school.  The class will be about the long-term issues that will affect the markets (sovereign debt, the deficit, Social Security, healthcare).  I’m really looking forward to this…but it’s a lot of work.  On to today’s thought for the day…

We’ve heard recent reports about stagnant wage growth and the ramifications.  Of course, if I’m not earning more, it’s hard for me to spend more…unless I borrow money.  Most Americans are not going to be able to borrow more – so what does that tell you about the next few years?

There are many reasons for stagnant wage growth, but here’s one factor: health care costs.  Since 1999, health insurance premiums have increased 160%!  (Employee contributions have increased 168%.)  Employers don’t want to raise salaries when they are already paying more for our health insurance.  Of course, employees are also paying more.  See Chart.

The Kaiser Family Foundation reported that the average annual premium for family coverage through an employer is $15,073 in 2011 – a 9% increase from 2010!  See slide below.

In addition, half of workers at small firms now have deductibles of $1000 or more.  In 2006, that was 16%!  At large firms, the number has grown from 6% to 22%.  See chart below.

Another real problem that results from this situation is that lower level employees become prohibitively expensive.  It’s hard to hire someone for $20K when insurance will drive the cost to $35K.  It’s much easier to outsource this job in many cases.

Have a good week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link  (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Before I get to this week’s blog, I was quoted in the Houston Chronicle on Friday.  The article is titled, “Fed Shoots Blanks as Worries Rise” and it was written by Loren Steffy.  Here’s the link.  I thought that Loren wrote a great article.  Now, on to today’s topic…

The IMF put out a short piece (“Painful Medicine” by Laurence Ball, Daniel Leigh and Prakash Loungani in the IMF’s Finance and Development publication) about the effect of austerity measures on economies.  (This was based on a longer piece of research that the IMF had published.)  Ultimately, they refute the idea that deficit reduction will lead to stronger growth and job creation in the short run.  They are not arguing that deficit reduction is bad or that it won’t help in the intermediate to long-term; rather, they are just saying that it will hurt in the short term.

The authors rely on recent IMF research showing that “over the past 30 years, consolidation lowers incomes in the short-term, with wage-earnings take more of a hit than others; it also raises unemployment, particularly long-term unemployment.”  This paper is significant because (if they are right), it tells us that we’re heading for a really long period of economic pain.  Below, you will find the key ideas (with many lifted directly from the paper and all charts are also their work).

The Problem

1. For advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans.  See Chart 1.

2. Public debt has increased in many countries due to the Great Recession: lower income, lower taxes, bailouts and stimulus.  Public debt in advanced economies has increased from 70% of GDP to approximately 100% of GDP.  This is the highest level in 50 years.  The problems are even more serious due to the aging population.

3. Many countries are trying to reduce debt by cutting spending and increasing taxes.

The Evidence

1. Over the past 30 years, there have been 173 episodes during which 17 advanced economies undertook budgetary measures aimed at fiscal consolidation.

2. The average size of fiscal consolidation was approximately 1% of GDP per year.

3. Fiscal consolidation raises unemployment and lowers income.  See chart 2.

4. A fiscal consolidation of 1% of GDP reduces inflation-adjusted incomes by about .6% and raises the unemployment rate by almost .5% within two years.

5. Spending by households and firms also declines.  There is no evidence of a handoff from the public to private sector.

Reducing the Pain

1. The reduction in incomes is even larger if central banks do not or cannot blunt some of the pain through monetary policy.  Lowering interest rates supports investment and consumption.

2. Unfortunately, in today’s market, central banks can do little because rates are already near zero.

3. If many countries carry out austerity at same time, the reduction in incomes in each country is likely to be greater, since not all countries can reduce the value of their currency and increase net exports at the same time.

4. Simulations show that reduction in incomes may be more than twice as large as that described above when many countries are carrying out consolidations at the same time.  The contractionary effect may be greater than historical events.

5. Historically, fiscal consolidations based on spending cuts are less painful than those based on tax hikes.  But, this has been true because central banks have cut interest rates more after spending cuts.

6. Fiscal consolidation may also seem less painful when markets are more concerned about the risk of a government defaulting on its debt.  In other words, if a country is tackling its fiscal situation, this can give confidence to investors, consumers and firms and can lead to more spending.  But, IMF research shows that these consolidations are still contractionary and there is no evidence of any surge in consumption and investment.

Long-Term Pain

1. Fiscal contraction has a bigger impact on long-term unemployment (when an individual is unemployed for longer than six months).  While the increase in short-term unemployment ends within three yeas, long-term unemployment remains higher after five years.  Fiscal consolidation hurts those who are already suffering.  See Chart 3.

2. Long spells of unemployment reduce the odds of being hired.  In the US today, a person unemployed for more than six months has only a one-in-ten chance of being rehired in the next month, compared with a one-in-three chance for a person unemployed less than a month.

3. Long-term unemployment also threatens social cohesion.  A survey conducted in 69 countries found that an experience with unemployment leads to more negative opinions about the effectiveness of democracy.  The effects were more pronounced for the long-term unemployed.

Inequity

1. For every 1% of GDP of fiscal consolidation, inflation-adjusted wage income typically shrinks by .9%, while inflation-adjusted profit and rents fall by only .3%.  Also, while the decline in wage income persists over time, the decline in profits and rents is short-lived.  See Chart 4.

2. Possible reasons for this include: austerity plans often call for public sector wage cuts and consolidations also increase unemployment.

The Bottom Line

1. We should have realistic expectations about short-term consequences of fiscal consolidation.  It is likely to lower incomes (hitting wage-earners more than others), raise unemployment (particularly longer-term unemployment) and will slow growth.

2. The potential benefits of consolidation are longer-term: reducing interest rates and lightening the burden of interest payments, permitting cuts to distortionary taxes (those that discourage desirable behavior).

3. We need to approve fiscal measures now that will kick in to reduce deficits in the future.  We need to link retirement age to life expectancy and improve the efficiency of entitlement programs.

4. In countries like the US (where unemployment is at high levels and long-term unemployment is at alarming levels), there is a need for policies to spur job creation and increase consumer confidence, including measures such as mortgage relief for distressed homeowners.

5. Fiscal consolidation plans should also spell out how policies would respond to shocks, such as slower growth than planned.  Fiscal plans succeed when they permit “some flexibility” while credibly preserving the medium-term consolidation objectives.

My Thoughts

I believe the authors are spot-on…we’re headed for significant pain.  Government spending is a significant part of our GDP.  It’s going to impact our growth when we cut this.  When we increase our taxes, that’s money that individuals won’t be spending.  Individuals are deleveraging and we’re also going to eventually need to do this collectively (with our public debt).  This isn’t a problem that is going to be solved in the next few years.  REMEMBER: this study explains what happens when we have fiscal consolidation that is 1% of GDP.  Our fiscal gap is closer to 8% of GDP. I believe that we’re headed for long-term slow growth that will impact financial returns, employment and wages.  I also believe that we’re headed for a time in which we see a further bifurcation between “the haves” and the “have-nots.”  This isn’t a short-term economic cycle.  It’s going to be a long-term economic reality.  The “new normal” should be called the “ugly new normal.”

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

This weekend, I read the Census Bureau report, “Income, Poverty, and Health Insurance Coverage in the United States: 2010.”  I know what you’re thinking…“wow, I want to party with you.”  There really are some interesting statistics in the report.  Here’s the link.   Here are some of the stats that I found interesting (all stats are for 2010 unless otherwise stated).  In addition, be sure to read the stat about Social Security below.

INCOME

Real median household income was $49,445, a 2.3% decline from 2009.

Since 2007, real median household income has declined 6.4% and is 7.1% below the 1999 peak.

The median household income of family households with married couples (rather than single parent) was $72,751.

Since 2007, the number of men working full time, year round with earnings decreased by 6.6 million and the number of women working full time, year round with earnings decreased by 2.8 million.

INCOME INEQUALITY

The annual change in income inequality was not statistically significant.

If you break the population into quintiles, here are the income levels to qualify and the percentage of total income received by that quintile:

1.   $20,000 or less — 3.3%

2.   $20,001 – $38,043 — 9.2%

3.   $38,044 – $61,735 — 15.1%

4.   $61,736 — $100,065 — 23.2%

5.    more than $100,066 — 49.3%

In 1999, people at the 90^th percentile made 10.42X what people in the 10^th percentile made.  In 2010, this had grown to 11.67X.

Income inequality is smaller when it’s calculated using an equivalence-adjusted income method.  This type of methodology would show that someone living alone and making $30K is better off than someone who makes $50K but has six kids.  There are a disproportionate number of single-person households and smaller families at the lower end of the income distribution.

POVERTY

The official poverty rate was 15.1% in 2010, up from 14.3% (2009).  In 2007, the rate was 12.5%.  Obviously, we normally see this number increase when there is a recession.

There were 46.2 million people in poverty.  It’s alarming to have more than 1/7 of our population living in poverty.

The poverty rate was the highest since 1993, but 7.3% lower than 1959.

It will be really scary to see what happens if we have another recession.  See chart below. 

The poverty rate for children under age 18 increased from 20.7% to 22%.

In 2010, 6.7% of all people (20.5 million) had income below one-half of their threshold poverty level.  This is 44.3% of the poverty population.

The average family living in poverty was $9,244 below the poverty level.

Some Positive Statistics About Poverty

From 2004 – 2007, approximately 31.6% of the population had at least one spell of poverty lasting two or more months.

But, chronic poverty was relatively uncommon.  Only 2.2% lived in poverty for all 48 months from 2004 – 2007.

Approximately 23.1% of the population experienced a poverty spell lasting two or more months in 2009, but only 7.3% were in poverty every month of 2009.

Why We Need Social Security

The number of people aged 65 and older living in poverty would be higher by 14 million if social security payments were excluded from money income.  This would quintuple the number of elderly people in poverty.  THIS WOULD MEAN THAT MORE THAN 45% OF SENIORS WOULD BE LIVING IN POVERTY WITHOUT SOCIAL SECURITY.  Obviously, Social Security isn’t going to be completely eliminated, but the point is that we have a serious problem and it’s going to hurt a lot of people when it’s cut.

If unemployment insurance benefits were excluded from money income, 3.2 million more people would be considered poor in 2010.

Health Insurance

In 2010, the percentage of people without health insurance was 16.3%.

The percentage of people covered by private health insurance decreased to 64%.  This number has been decreasing since 2001.

Approximately 55.3% of people are covered by employment-based health insurance.  This is down from 56.1% in 2009.  Approximately 9.8% of the population is covered by direct-purchased insurance.  (Some people have both employment-based insurance and another policy that they bought.)

The percentage of people covered by government health insurance increased to 31%.  (Realize that the percentage of people covered by private plus public insurance makes it sound like there are less than 16% uninsured.  The reason for this is that some people are covered by both public and private insurance.)

Approximately 15.9% of people are covered by Medicaid and 14.5% are covered by Medicare.

26.9% of people in households with incomes less than $25,000 had no health insurance coverage.

8% of people in households with incomes of $75K or more were uninsured

The uninsured are a much larger portion of the south (19.1%) than the west (17.9%), midwest (13%) and northeast (12.4%).

Have a great week.

_______________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Two quick ideas to pass on:

First, you really should read “Walking Out in China” (in The New York Times) by Liao Yiwu.   He is a Chinese writer who was imprisoned for four years for writing a poem that condemned the Chinese government for their 1989 actions in Tiananmen Square.  Here’s the link.  It will take you two minutes to read.  Liao Yiwu’s story (and you can read more about his life here) makes me think of Nobel Peace Prize winner Liu Xiaobo (who continues to serve an 11 year sentence).  It’s horrifying to think that we’re indebted to the Chinese government.  This might be the absolute worst part of our years of fiscal mismanagement.

Second, Christine Lagarde (Managing Director of the IMF) spoke on Thursday.  She made a great comment:

I believe there is a path to sustained recovery, much narrower than before and getting narrower.  To navigate it, we need strong political will across the world – leadership over brinksmanship, cooperation over competition, action over reaction.

Amen sister.  We’re running out of time.  It gets worse every day.  We need a lot better than we’re getting from the politicians.

She further pointed out that we have three problems:

1. balance sheet pressures are sapping growth (she referred to the balance sheets of governments, financial institutions and households)

2. instability in the core of the global economic system

3. social tensions – The social tensions (that she described) include “entrenched high unemployment, especially among the younger generation; fiscal austerity that chips away at social protections; perceptions of unfairness in ‘Wall Street’ being given priority over ‘Main Street’; and legacies of growth in many countries that predominantly benefited the top echelons of society.”

I agree with her.  We have financial problems and we have political problems.  That’s what scares me — our fiscal problems would be difficult to solve if we could all get along.  But, as political animosity intensifies, our chances of finding a real solution become smaller.

Have a great weekend.

_____________________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Dallas Fed President Richard Fisher spoke on Monday.  I’ve put a summary of his comments below.  In addition, I never posted my comments on President Obama’s job proposal (for a variety of reasons).  But, here are the main ideas:

1. Lowering the employer portion of Social Security (on the first $5MM of salary) is not going to increase hiring.  Employers will not hire someone because there is a “3.1% off” sale.  They’ll hire someone if demand increases.  (Obviously, the hope is that the tax cuts will increase demand…we’ll see.)  But, small businesses are the winners.  Also companies that were already planning on hiring are big winners (because they will temporarily get out of paying the entire 6.2% Social Security payroll tax).

2. We’re sending a bad message about the problems we have with Social Security and Medicare when we try to fix other problems by lowering the payroll tax.  Medicare and Social Security are our biggest long-term problems.  Getting employees and employers used to lower taxes will only compound these problems.  (You might also remember that the Bush tax cuts were supposed to be temporary, but we seem to have a hard time going back to the old rates.)

3. My favorite part of the White House’s fact sheet says, “the American Jobs Act will specify that Social Security will still receive every dollar it would have gotten otherwise, through a transfer from the General Fund into the Social Security Trust Fund.”  What does that mean?  Our General Fund, which borrows from the Social Security Trust will give money to the Social Security Trust?  All this means is that we’re going to stick more special US Treasury securities in the Trust Fund.  But, I guess it’s better than having to sell them to the public…

Main Thoughts From Dallas Fed President Fisher

1. At the end of Q1, average per capita net worth was nearly 14% below the peak seen four years earlier.  (Bad news – it’s going to be a lot lower at the end of Q3!)  Real income is almost 2% below its peak in Q1 2008.  He suggested that income dispersion has increased in the past few years, so the median income has probably fared worse (than the average).

2. Our GDP performance has followed the typical (worldwide) GDP drop that results from a financial crisis.  See the chart below.  Notice that the chart indicates that this will be ugly for a long time.

3. He asked how we can change this picture.  We need job creation, income growth and wealth restoration.

4. We’re constantly looking for quick fixes.  He said that the Fed has to resist doing something that would contradict their long-term responsibility.

5. He re-listed the reasons why he opposed the Fed’s recent statement saying that they would keep rates at exceptionally low levels at least through mid-2013:

A. he thought it would be viewed as a commitment

B. it provides incentive to delay borrowing (you know rates will stay low)

C. the Fed needs Congress to fix the fiscal problems and reduce regulation

D. at the time of the meeting, the debt ceiling debate was just ending and it looked like the Fed was reacting to short-term market moves (and that a Bernanke put existed)

6. Currently, the Fed has provided enough liquidity.  Confidence is lacking because of fiscal and regulatory authorities.  We must incent private businesses to expand investment, hire workers and lift income and net worth.  But, we must do this without hurting our finances.  (Unfortunately, I would argue that this is very difficult to do when households are deleveraging and the public debt is becoming overwhelming.)  He said that confidence is also lacking because of the European debt crisis.  Monetary policy is not causing a lack of confidence.

7. He did say that the Fed must reduce the regulatory burdens that are inhibiting community bankers.

8. He cited an Economist article to say, “there is moral hazard in central-bank activism.  It risks encouraging governments to sit back and let others do the work that they find too difficult themselves.”

9. We got a view of what he thinks about the possibility of “Operation Twist” (selling short term Treasuries and buying longer-term Treasuries) when he referred to it as “jujitsu with the yield curve.”  Enough said.

Have a great week.

___________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Short blog today.  I had actually written a piece about the President’s Jobs Act and the idea of cutting the payroll tax.  But, I want to think about the issue some more.  Instead, I want to share an idea that came from Bill Gross in a piece that he wrote in The Financial Times.  It was titled, “Helicopter Ben Risks Destroying Credit Creation” and here is the link.  Here’s my summary of his thoughts:

You often hear about the Fed raising or lowering interest rates.  But, aside from the demand for loans, there are really two things that matter to lending: (1) the interest rate; and (2) the shape of the yield curve.  Normal yield curves (where longer term rates are higher than short-term rates) are a positive for banks – which borrow short-term and loan long-term.  This really makes you question the idea of the rumored “Operation Twist” (where the Fed would sell some of their shorter-term maturities and buy longer-term Treasuries).  It seems like it has the possibility of flattening the yield curve and that’s not good.

____________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. go to www.leedsonfinance.com
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Is anyone really surprised at the lousy employment report that we saw on Friday?

Today’s blog has several parts:

1. A quick summary of the employment report

2. Some interesting numbers from a recent Business Week article

3. Some comments from Atlanta Fed Pres. Lockhart (which reinforce the idea that our labor market is going to be terrible for a long time)

4. My football thought for the week

Part 1: Quick Summary of the Employment Report

We created no new jobs in the past month. The unemployment rate is still 9.1%. Our unemployment rate is low because many people have left the work force (dropping our participation rate).  If our participation rate (the percentage of adults who are either employed or actively seeking employment) was 66% (we’ve been as high as 67% in the past decade) our unemployment rate would be 11.8%.

The reality is that certain groups are fine and others are not keeping up. The unemployment rate for people with a college degree is 4.3%. The unemployment rate for people with some college (but not a degree) is 8.2%. The unemployment rate for high school graduates (with no college) is 9.6%. The unemployment rate is 14.3% for those who have not completed high school.  We need to find a way to educate people.  Otherwise, the odds are against you.

In addition, we also see that there is a direct relationship between education and participation in the labor force (where you either have a job or are actively searching for a job). Approximately 76% of college graduates are in the labor force. For high school graduates who have some college (but not a degree), the participation rate is 69.2%. For high school graduates (with no college), the participation rate is 60%. For people who have not completed high school, the participation rate is 46.7%.

Part 2: Business Week Article

Here are some really interesting stats (taken directly) from a Business Week article titled, “The Slow Disappearance of The American Working Man”:

A. The portion of men holding a job (full-time or part-time) fell to 63.5% in July.

B. Only 81.2% of men between the ages of 25 and 54 held a job. In the 1982–83 recession, this fell to 85%. In 1969, this was 95%!

C. After accounting for inflation, median wages for men between the ages of 30 and 50 dropped 27% (to $33,000 a year) from 1969 to 2009.

D. Women now account for 57% of college students. But, they continue to earn about 16% less than men.

E. Since 1970, the fraction of 25 to 60-year-old men on disability has more than doubled, from 2.4% to 5%.

Part 3: Fed President Lockhart

Atlanta Fed Pres. Lockhart said that there are three likely protracted and interconnected adjustment processes of significance that are going on:

1. Deleveraging

2. Fiscal adjustment

3. Financial system repair

He said it best last week (click here for the transcript of his speech), warning that “these deeper impediments to growth imply structural adjustments in the economy that may take years to accomplish before the economy achieves full and well-balanced health.”

Lockhart cited some interesting statistics.  Read them below (again, most of these are direct quotations).  Here’s my conclusion: while companies and individuals have been deleveraging, the government has been increasing its debt.  As a result, we have not made any progress in the deleveraging process and we’re in for a really long, ugly time.  Here are the stats he cited:

A. Total domestic debt of nonfinancial sectors of the economy reached 248% of GDP in 2009. This was almost a 75 percentage point increase in the decade.

B. During the 1990s, the amount of outstanding mortgage debt of households was relatively stable at around 45% of GDP. But, from 2000 to 2007 household mortgage debt increased to almost 75% of GDP.

C. Household deleveraging has occurred mostly from a combination of increased savings, debt repayment, and also debt forgiveness.

D. From its peak in 2009, total household debt has declined to around 90% of GDP (the lowest level since 2005), and the household savings rate has risen to about 5%.

E. Debt in the nonfinancial business sector has also increased over the last decade, reaching a historical high of 79% of GDP in 2009. By the 1st quarter of 2011, nonfinancial business debt had declined to about 73% of GDP. As a point of reference, some research argues that nonfinancial business sector debt becomes a drag on economic growth after it increases to about 90% of GDP.

F. In contrast to reductions in debt by households and businesses, government debt has surged, increasing from about 50% of GDP prior to the recession to around 80% in the 1st quarter of this year.

G. While the private sector (households and businesses) has made notable progress in lowering its debt burden, discussions of how to reduce public debt have only just begun. The government still needs to introduce major policy changes to put public debt on a sustainable path. Demographic trends will make public debt reduction even more challenging.

H. McKinsey surveyed 32 international periods of deleveraging following financial crises and found that, on average, the duration of these episodes was about 6 and half years.

Lockhart’s conclusion: It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending they divert more of their incomes to pay off debt. This increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainty about the future.

Part 4: My Football Thought For the Week

College football has returned.  Life is good.  Did you watch the Notre Dame game?  Due to storm delays, the game last several hours longer than it was supposed to.  It was absolutely awesome.  I was able to enjoy Notre Dame losing for eight hours, rather than the normal three and a half.

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link  (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Ben Bernanke spoke in Jackson Hole on Friday.  In case you’re not aware of this, the Jackson Hole conference is put on by the Kansas City Fed.  It’s a “who’s who” of central banking, industry and academia.  In addition to Bernanke’s speech, some of the other papers (that were presented) are particularly interesting.  Hopefully, I’ll have time to write about one or two of them in the future.  Until then, here’s the link if you want to see them.

Bernanke’s speech was much awaited by investors, yet the market viewed it as pretty uneventful.  Of course, last year at Jackson Hole, Chairman Bernanke started discussing QE2.  There were no big Fed plans that were announced this year.  Yet, I would argue that Bernanke’s comments are particularly important.  Below, I’ll explain why (in the first half of the blog).  The second half of the blog is less important, but I’ve provided you with some of Bernanke’s summaries of issues.

Part 1: The Most Significant Takeaways From Bernanke’s Speech

1. Bernanke let us know that we’re out of monetary bullets.  While he said, “The Federal Reserve has a range of tools that could be used to provide additional monetary stimulus,” it’s hard to believe this within the context of his other comments.  He admitted that our recovery was modest at best and unemployment was too high.  When the bad guys are knocking in your front door, this is the time to use your bullet if you have one.  It’s not the time to announce that you have some more bullets.  (I would argue that this just confirms what most of us already knew – the Fed has provided all of the liquidity that they can.  That’s not the issue we face.)
2. His speech might signal the power of the dissenters.  If Bernanke does want to try firing more bullets (which may be blanks), he probably doesn’t think he can get away with it after three members of the FOMC dissented from keeping the Fed Funds rate near zero for two years.
3. Bernanke is clearly putting the blame on fiscal policy and politics in general.  He said, “most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.”  In addition, he commented that, “The quality of economic policymaking in the US will heavily influence the nation’s longer-term prospects.”  He continued by saying that policymakers must “promote macroeconomic and financial stability; adopt effective tax, trade and regulatory policies; foster the development of a skilled workforce; encourage productive investment, both private and public; and provide appropriate support for research and development and for the adoption of new technologies.”
4. He reiterated that we are headed to financial ruin if we don’t make big changes.  “To achieve economic and financial stability, US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time.” He summed it all up when he said,  “without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage.”
5. We can’t repeat the behavior of July and August.  He said, “the country will be well served by a better process for making financial decisions.  The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold US financial assets or to make direct investments in job-creating U.S. businesses.”
6. Bernanke sounded as if he wants something close to a balanced budget amendment or possibly a goal related to a debt-to-GDP ratio.  He said, “fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of these goals.”
7. We need politicians to be leaders and we need to educate society.  Bernanke said, “Of course, formal budget goals and mechanisms do not replace the need for fiscal policymakers to make the difficult choices that are needed to put the country’s fiscal house in order, which means that public understanding of and support for the goals of fiscal policy are crucial.”

I agree with Chairman Bernanke.  We are out of bullets.  Even if the “perfect” policies are in effect (whatever you may believe they are), it’s going to take time to get the housing market, the labor market and the financial system back to health.  But, we’re never going to do this if politicians continue their behavior.  Most importantly, we’re never going to convince the politicians to behave responsibly when our citizens have little understanding of the financial issues.  Bernanke referred to the “public understanding” of fiscal policy.  The majority of Americans can not define an unfunded liability.  So you tell me how we will have “public understanding.” All I can say to that is “good luck.”

Part 2: Other Comments by Bernanke

This part of the blog is less important.  But, here are some of the other ideas that Chairman Bernanke shared:

1. While important problems exist, the long-term growth fundamentals of the US do not appear to have been permanently altered by shocks of the past four years.  Normal growth and employment rates will return.  This reminds me of talking to Jenny about being married to me and we were talking about my life insurance policy.  She said that she’s “pessimistic about her immediate future, but optimistic about the long-term.”
2. There have been some positives: while the US recovery has been “modest”, it is in its ninth quarter; the banking system is much improved; credit from banks has improved (though still tight in categories); companies with access to the bond markets have been able to raise capital; structural reform is underway in the financial sector; manufacturing has risen 15% from its trough (trade deficit is lower); business investment in equipment and software continues to expand; productivity gains in some industries have been impressive; households are reducing debt; and commodity prices are off their highs.
3. Unfortunately, the recovery has been weaker than expected.  The recession was deeper than we first thought; aggregate output in the US has not returned to its pre-crisis level; growth has been insufficient to significantly lower unemployment; and while temporary factors affected the economy, there were also more persistent factors at work.
4. Recessions normally sow the seeds of their recovery.  There is pent up demand, stimulative policy, increased production and higher employment.  This recession is different because of the deep downturn in the housing market and a historic financial crisis.
5. The FOMC expects a moderate recovery to continue and to strengthen over time.  The expect inflation to settle over coming quarters at or below 2%.
6. Bernanke said that he does not expect the long-run growth potential of the US economy to be materially affected by the crisis and recession IF (and he stressed if) our country takes the necessary steps to secure that outcome.  Home prices will stabilize as more households form; financial markets have already made progress toward normalization; the financial sector will continue to adapt to reforms; households will continue to strengthen their balance sheets; business will continue to invest in new capital.
7. We have long-term advantages: the US economy remains the largest in the world with a diverse mix of industries and a degree of international competitiveness that (if anything) has improved in recent years; we have a strong market orientation, a robust entrepreneurial culture and flexible capital and labor markets; and we remain a technological leader with many of the world’s leading research universities and the highest spending on R&D of any nation.
8. We have growth challenges: our population is aging, our K-12 educational system poorly serves a substantial portion of our population; the costs of health care in the US are the highest in the world without fully commensurate results.
9. Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs.  Our nation’s tax and spending policies should increase incentives to work and to save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development and provide necessary infrastructure.
10. We cannot expect our economy to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs we face.

________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. go to this link    (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Before I start today, I want to give you one quick thought about current news.  I hear so many people talking about Chairman Bernanke’s upcoming Jackson Hole speech (on Friday).  I personally don’t understand what monetary policy would make investors happy.  My opinion is that we have a deleveraging problem (leading to weak demand) and we have a huge overhang (based on the idea that programs are going to get cut and taxes raised).  Will buying more Treasuries or shifting the Fed’s portfolio from short-term Treasuries to long-term Treasuries change our growth?  Call me a skeptic.  Now, on to an interesting study…

If you want to read an absolutely frightening piece (and if you don’t, why do you subscribe to my blog?), here it is.  Two SF Fed economists (Zheng Liu and Mark M. Spiegel) wrote, “Boomer Retirement: Headwinds for U.S. Equity Markets.”  (You can find the study at this link.)  Here are their thoughts:

1. The baby boomers (born between 1946 and 1964) are likely to sell off acquired assets as they phase into retirement.
2. This could put downward pressure on the market, just as the stock market tries to recover from the financial crisis.
3. Some studies attribute the sustained asset market booms in the 1980s and 1990s to the fact that the baby boomers were entering their middle age years.
4. The authors compared the valuation of the market to the age of investors.  They used the S&P 500 for the P/E.  For the age of the investors, they used the “M/O” ratio: middle age cohort (40 – 49) / old age cohort (age 60 – 69).  In other words, think of it as how many middle age citizens there are relative to older citizens.
5. Think of stock prices as earnings multiplied by the P/E ratio.  The M/O ratio explains about 61% of the movements in the P/E ratio.
6. This model estimates that the P/E ratio should decline from 15 in 2010 to approximately 8 or 9 in 2025, recovering slightly in 2030 (to slightly above 9).  See chart below idea 9.
7. Real earnings have grown 3.42% annually from 1954 to 2010.
8. Based on this model (assuming earnings continue to grow at 3.42%) real stock prices follow a downward trend until 2021 (because of multiple contraction), cumulatively declining about 13% relative to 2010.  Stock prices would not return to their 2010 level until 2027.
9. The M/O ratio rebounds in 2025.  By 2030, the real value of equities should be 20% higher than in 2010.

The authors said that there are several scenarios which would derail their theory:

1. Demographic trends are predictable and should be anticipated.  So stock prices should already reflect anticipated effects of the aging of our citizens.
2. Retired individuals may continue to hold equities (in case they live longer or for their heirs).
3. Foreign demand might also reduce downward pressure on the multiple.  (But, this is unlikely to help because other developed nations are aging even more rapidly than the US; in addition, investors show a home bias in equity holdings.)
4. There are many other factors that may drive demand for stocks.  Some researchers found that long swings in P/E ratios are correlated with relative volatility in bond and equity markets and long-term bond yields.  Also, foreign investor taste for U.S assets may change.  If China relaxed their capital controls and allowed Chinese nationals to buy stocks, it cold make a difference.

My Concluding Thoughts

These authors are arguing that the multiple (that is applied to earnings) is based on demographics.  From a more academic (mathematical) perspective, we tend to think that multiples decrease if earnings are expected to grow at a slower rate, if companies are less efficient (lower asset turnover, lower margins, etc.), interest rates are higher and the perceived riskiness of earnings is high.  As a result, this study is not perfectly in line with our academic theory.  Of course, it could be possible that when more of our citizens are older, growth slows and earnings are perceived to be riskier.  If this study turns out to be correct, by 2030 investors will have had close to 30 years of no real returns.  Few people save enough money to retire based on a real return of zero.

_____________________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. go to this link   (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

I’m writing this Friday afternoon about an hour before I go to the circus.  (I’m referring to Barnum & Bailey, not DC.)  The market closed a couple of hours ago.  You know things are dismal when my thought is “down 173…that’s not too bad.”

Dallas Fed President Richard Fisher gave a speech this past week and I want to share some of it with you.  I’m skipping the first half of his speech, but I’m going to visit that in a future blog.  He discussed (in the first half) the Texas job growth that so many people are arguing about (because of Governor Perry).  Speaking of the Governor, I was quoted by Bloomberg / Business Week in their story about Governor Perry’s comments about how Texas would treat Fed Chairman Bernanke.  Here’s the link.

Fisher told us why he dissented when the FOMC said that they would likely maintain low rates for the next two years.  He gave three reasons:

1. Liquidity is abundant.  There are $1.6 trillion of excess reserves at the Federal Reserve banks, private equity firms have cash and corporations may have more than $1 trillion of excess working capital.  The Fed has a huge balance sheet and does not need to commit to more or to signal further accommodation.

2. Further accommodation can not impact the nonmonetary factors that are “retarding the willingness and ability of job creators to put to work the liquidity that we have provided.”  Businesses cannot budget or manage for the uncertainty of fiscal and regulatory policy.  They see uncertain demand in their business and this was compounded by the debt ceiling negotiations.  People delayed expenditures as both parties talked about the financial disaster that could occur.

Importantly, nothing was clarified by the resolution to the debt ceiling negotiations!  There will be undefined change in taxes, spending and subsidies and other fiscal incentives or disincentives.  How should a business owner behave when demand is weak and they have no idea where the government will cut back on spending, what will happen with taxes and how this will impact your cost structure or customer base.  Add in the fact that the Fed has promised to keep rates low for two years – so why act now?

As an aside (from me, not President Fisher)…I was really interested by his argument that promising to keep rates low for two years could slow demand since people now know that they have a long time to act before rates increase.  It’s the flip side of an interesting (counter-intuitive) argument that some people have made recently: we need to signal that we’re going to increase rates so that people see this as their last opportunity to buy a house and get a cheap mortgage.

Fisher suggested that it’s going to be hard to add employees or have meaningful capital expenditures until we have clarity from Congress as to how they will “bend the curve of deficit and debt expansion.”  Monetary accommodation can’t substitute for that clarity.  It’s only going to be made worse if people think that the Fed is going to try to inflate their way out of this problem.

3. Fisher was also nervous that tweaking the statement language would encourage the view of a “Bernanke put” (the idea that the Fed will always step in when the stock market corrects).  Fisher believes that his FOMC colleagues all share the view that the Fed should not bail out investors – but he’s worried that the market believes the Fed will.

Fisher summed up his thoughts by saying “the ugly truth is that the problem lies not with monetary policy but in the need to construct a modern, appropriate set of fiscal and regulatory levers and pulleys to better incentivize the private sector to channel money into productive use in expanding our economy and enriching our people.”

One last (somewhat unrelated) note from the speech…Fisher said that while many companies have begun to raise prices to counter the 2010 commodity run-up and increases in Chinese production costs, weak demand is making it hard to pass these increases on.  So, while seen as a hawk, fear of inflation was not why he dissented.

Finally, I saw Philadelphia President Plosser explaining his dissent on Bloomberg.  He said that he thought the FOMC’s statement was too pessimistic, he didn’t like the date (mid 2013) and he was bothered by the idea that it sounds like a promise when it really isn’t.

_______________

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. go to this link  (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.