Friday, October 08, 2010

More Evidence of Unlearned Lessons At The Fed

Today's lead Wall Street Journal staff editorial, The "Limited Inflationists," was a real eye-opener.

In it, the author identified Sumner Slichter, a Harvard University economist in the 1950s, as the intellectual father of the notion that a little managed inflation is good for an economy.

Early on, the piece states,

"In a hearing on Capitol Hill, his views drew a famous rebuke from Fed Chairman William McChesney Martin, but Slichter's ideas gained currency in the 1950s and 1960s and eventually laid the groundwork for the not-so-gradual inflation of the 1970s.

Slichter died in 1959, but he is staging a rebirth at none other than Martin's former home, the Federal Reserve. A galaxy of Fed officials has fanned out to argue for another round of "quantitative easing," or a further expansion of the Fed balance sheet to boost the economy. The "limited inflationists" are once again at America's monetary helm, promising happier days from rising prices while downplaying the costs and risks."

The editorial then goes on to detail the various players on the Fed Open-Market Committee who are now targeting inflation levels, claiming there is wiggle room, because the actual rate of inflation is below their target, so a little more of it won't hurt.

The author offers some evidence that the QE2 planned to effect this inflation won't achieve very much for the $500B spent.

But the real message comes near the end of the editorial,

"The case for QE2 assumes that the problem with the economy is merely a lack of money. But trillions of dollars are already sitting unused on bank and corporate balance sheets. The real problem isn't lack of capital but a capital strike, as businesses refuse to take risks or hire new workers thanks to uncertainty over government policy, including higher taxes and regulatory burdens. More Fed easing in this environment risks "pushing on a string," adding money to little economic effect.

By keeping interest rates artificially low, the Fed is also contributing to a misallocation of capital and perhaps new asset bubbles. Messrs. Bernanke and Evans say they see no signs of inflation, as measured by the lagging indicator of the consumer price index."

These are both very important points.  Most informed observers of the current business situation understand that the author is correct. It's uncertainty with respect to governmental actions on many fronts that has immobilized capital and investment, not rate levels. And more bubbles and capital misallocation are likely, in a repeat of Greenspan's mistakes of the early years of the past decade.

"But investors are having no trouble bidding up the price of commodities, including oil and gold. A rising price of oil will have its own negative impact on growth, as we know from the experience of $147 oil in mid-2008. A commodity price spike might well erase any benefit from the expected decline of 15 basis points in long-term bond yields."

This is a particularly astute observation. Bernanke & Co. are running around announcing that, since the CPI and other baskets of goods aren't rising too fast in price, there's little inflation. They conveniently ignore the commodity bubbles now building. CNBC's Rick Santelli has noted this often in the past months.

Why is, in years past, Fed officials admitted, in hindsight, to asset pricing bubbles, but now, while observing them again, they choose to blithely ignore them and focus on more benevolent measures which are currently behaving to their liking?

Finally, the editorial delivers the coup de grace,

"As the protector of the world's reserve currency, the Fed also risks more global monetary disruption. The mere anticipation of QE2 has already caused Japan to pursue its own purchases of exotic assets, while Britain may do the same, as they and other countries try to avoid sharp rises in their currencies against the dollar. The European Central Bank may well have to follow, as the entire world adopts the "limited inflation" philosophy. In such a world, it's hardly surprising that gold has climbed in price against all major fiat currencies as a remaining store of value."

Forget all the foregoing technical points, if you wish. The argument which should trump all others is that of the Fed standing for price stability for the world's reserve currency. If it doesn't choose to do this, it is abdicating an important responsibility, and inviting further efforts to dethrone the dollar from this role.

That would be a mistake from which America, like Great Britain in the early 1900s, will probably never recover. Thus, the final paragraph of the piece,

"Which brings us back to Sumner Slichter and the limited inflationists. Amid the political and media interest in their ideas, Fed Chairman Martin appeared before the Senate Finance Committee. "There is no validity whatever in the idea that any inflation, once accepted, can be confined to moderate proportions," the father of the modern Fed thundered, in a warning that would be vindicated after his retirement in 1970. That's a warning as well for the QE Street Band."

No kidding. Just ask Paul Volcker.

More Old News: Mohamed El-Arian On CNBC Yesterday Morning

CNBC seems to have made a habit out of worshipping every word that emanates from Mohamed El-Arian's lips. Yesterday this foolishness reached a new low.

At one point, Joe Kernen actually said, to paraphrase as closely as I can recall,

'Shouldn't you be saying "Grasshopper" at some point here?'

Only it wasn't said, as El-Arian claimed, mockingly. Instead, the anchors treated El-Arian as if his comments were all new and insightful.

Ironically, El-Arian has run out of things to say. Having published his "New Normal" book, and flogged the idea ceaselessly for months on the CNBC morning program, he's pretty much a dry hole now.

I'm not the only person who, since September, 2008, has expounded upon the global trend toward deleveraging. El-Arian talks like he's just discovered this concept.

When he turns to monetary policy, again, El-Arian rambles on in a self-important tone as if nobody else has ever studied, nor read erudite Wall Street Journal editorials about global monetary economics, central banking, price stability, global trade, etc.

There were a few other topics which received El-Arian's now-trademark arched, "I'm telling you a secret idea which I just invented" delivery.

It's gotten old. Fast.

Back in the day, a close friend in the fixed income business taught me how being part of, at that time, Salomon Brothers, conferred information advantages on traders who, stripped of their position at the then-dominant fixed-income trading and underwriting firm, would founder.

I often wonder how much of El-Arian's sudden fame 'insights' are a function of his being at PIMCO, rather than himself, per se. It's become the same with Bill Gross, except Gross is more transparent concerning his motives.

El-Arian has adopted the mantle of global fixed income and general investing statesman, trying very hard to convince you he's an objective, disinterested pundit on all things macroeconomic and financial.

For me, at least, that charade has ended. If you listen carefully now, you'll usually find that El-Arian isn't saying anything new, or even particularly insightful. Certainly little that other guests haven't said before.

But, in the cozy, mutual-back-scratching world of CNBC, fawning over certain guests from large, market-moving institutional investors fills airtime and makes for good headlines, while continuing to offer said guests the opportunity to talk their book while appearing to just be a smart person commenting objectively on world financial events.

Mohamed El-Arian seems to have become permanently lodged in that space now on CNBC.

Thursday, October 07, 2010

Old News: We Have Too Much US Financial Services Capacity

In a recent Wall Street Journal editorial, frequent, if often misguided contributor Andy Kessler proclaimed,

"There are too many traders, bankers and salesmen to support the new level of business. Thanks to Dodd-Frank, the shrinking of finance will continue."


Sorry to break the news, but, as I've written in prior posts on this blog over the past few years, US financial capacity has been excessive, and shrinking, since the 1990s. Even before, really.

In part, the simple applications of computer technology began to create excess capacity as long ago as the 1960s. It hasn't stopped since.

Kessler evidently thinks his insight is a surprise, or at least news.

It isn't.

He's right about the old retail brokerages and investment banks shamelessly inventing new, less efficient, higher-margin products for decades since the Big Bang deregulation of stock commissions in the 1970s. And among the consequences of the recent regulatory legislation will certainly be the elimination of prohibited activities at publicly-owned commercial banks.

But the much larger, more important trends in the sector have been the continuing growth of excess capacity, depressing margins and causing riskier trading and underwriting behavior, coupled with the exit of the best talent to hedge funds and private equity groups.

Put the two together, as Kessler failed to do, and you have your recipe for the recent financial disaster.

Forget "What's the Matter With Wall Street," the title of Kessler's editorial. There's really no Wall Street left, with Goldman Sachs' and Morgan Stanley's conversion to commercial banks.

It's more a matter of US financial services, generally, being over-supplied with capacity that simply can't be afforded. The sooner the capacity is taken out, the better for the nation and its competitive financial institutions.

Wednesday, October 06, 2010

Art Laffer On Washington State's Personal Income Tax Initiative

Art Laffer took on the Bill Gates, Sr. and Jr., of Washington state, in one of yesterday's Wall Street Journal editorials. The Gates' are pushing hard for the state to institute a new personal income tax.

Here's how Laffer described it,

"Mr. Gates Sr. has personally contributed $500,000 to promote a statewide proposition on Washington's November ballot that would impose a brand new 5% tax on individuals earning over $200,000 per year and couples earning over $400,000 per year. An additional 4% surcharge would be levied on individuals and couples earning more than $500,000 and $1 million, respectively.

Along with creating a new income tax on high-income earners, Initiative 1098 would also reduce property, business and occupation taxes. But raising the income tax is the real issue. Doing so would put the state's economy at risk.

To imagine what such a large soak-the-rich income tax would do to Washington, we need only examine how states with the highest income-tax rates perform relative to their zero-income tax counterparts. Comparing the nine states with the highest tax rates on earned income to the nine states with no income tax shows how high tax rates weaken economic performance."

Laffer's a good, empirical economist. He immediately took ends of the distributional spectrum of US states with respect to tax rates, and found,
"In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51%, and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%.
Over the past 50 years, 11 states have introduced state income taxes exactly as Messrs. Gates and their allies are proposing—and the consequences have been devastating.
Over the past decade, the nine states with the highest tax rates have experienced tax revenue growth of 74%—a full 22% less than the states with no income tax. Washington state has done better than the average of the nine no-tax states. Why on earth would it want to introduce a state income tax when it means less money for state coffers?

What's true for those states with the highest tax rates is doubly true for the 11 states that have instituted state income taxes over the past half-century. They too have lost huge sums of tax revenue."

Here's the revealing table from his editorial.

As a sort of coup de grace, Laffer offered this,
"A final thought for those who want to punish the rich for their success: As the nearby chart shows, those states with the highest tax rates, and those states that have introduced state income taxes, have seen standards of living (personal income per capita) substantially underperform compared to their no-tax counterparts."
I won't quote his parting shot to the Gates, but you can guess the nature of it.
Just focusing on Laffer's statistics and chart, it's a stunning picture that he paints. With the publication of this piece, why would any state be mad enough to initiate a personal income tax? Or raise the rate of one it already has?
Laffer doesn't mention it, but, surely, the same relationships must hold between countries, as well.
He has done a wonderful job providing clear, unmistakable evidence that higher tax rates depress standards of living and output. Period.

Tuesday, October 05, 2010

Lee Cooperman Today On CNBC

Omega Advisers founder and chairman, and former Goldman Sachs equity strategist, Lee Cooperman, was a guest host on CNBC this morning for an hour or more.

I don't feel terrific having to write this, because content should trump delivery, in an ideal world.

Someone has to tell Cooperman to lose the now-grotesque comb-over. Wear a hat, a toupee, go bald. Whatever it takes.

The grossly unflattering camera angles on the set showed his head from virtually all angles. It was decidedly not pretty.

I confess that his message, whatever it was, was, for me, lost in the presentation. But the one thing I did hear him say was to simply agree with David Tepper's comments two Fridays ago.

Oh, yes, there was Cooperman's big announcement that he's donating half of his considerable fortune to charity. All the liberals on set congratulated him for being a 'good corporate citizen,' implying that anyone who desires to keep his hard-earned money is somehow evil and anti-social.

That's some steep price to get on CNBC these days, isn't it? Or maybe just for Lee?

Other than that, Cooperman didn't seem to say much of interest.

Economic Lies Yesterday On CNBC

David Goodfriend, billed as a 'former Clinton White House staffer,' was a guest on Larry Kudlow's late-morning CNBC slot yesterday. He was the Democratic liberal of a pair debating the TARP program on the day of its notional closure. Never mind that billions of TARP funding still support AIG and Citigroup.

Goodfriend's comments provided an excellent example of how careful you have to be in believing what you hear on CNBC.

At least twice, I heard him baldfacedly state that 'every economist agrees that TARP helped us avoid what was going to be the next Great Depression.'

His exact words may have differed a bit, but not the sentiment. He was very clear that "every economist" agreed that, but for TARP, "we would have had another Depression."

No question, no debate. Goodfriend said so.

Later, Goodfriend professed to not have wanted the TARP, then offered what he felt should have been required attachments to TARP fund conditions. These included the laughable notion that banks would have been given the funds with the requirements that they be lent out, with no particular way of ensuring that such government-mandated loans wouldn't become the next chapter of the Fannie and Freddie credit policies which started the whole financial meltdown in the first place.

Such is the nature of Goodfriend's intellect, awareness of economics and finance, and prejudices.

However, it turns out that Alan Reynolds, and economist, has written several Wall Street Journal editorials, about which I wrote posts, found under the 'Alan Reynolds' label, specifically disputing the egregious use of federal power to prolong and deepen this recession, just like FDR did in the 1930s Depression.

Phil Gramm, former Democratic House Member and Republican Senator also wrote a recent Journal editorial along the same lines. He, too, disputed the need for the excessive federal measures of the past few years.

Goodfriend is wrong. He lied.

It is simply untrue that every American economist agrees that TARP was necessary and appropriate.

It's bad enough that CNBC has guests who lie, but its worse when nobody even bothers to challenge the lies. And it was the sort of 'big lie' that, left unchallenged, leaves many uninformed people simply believing that it must be true that there wasn't one economist in the US who disagrees with the proposition that, if not for TARP, the US would have been in another Depression.

Monday, October 04, 2010

Gillette's 34-Cent Razor

I love a good marketing success story, and Friday's Wall Street Journal showcased what may become a terrific one at Gillette.

Gillette, now part of Procter & Gamble, has developed a 34-cent razor with an accompanying 11-cent blade for its Indian markets. The current price of a Mach 3 blade in India is about $2.25. Quite a stunning change in price points. And, as it turns out, product features.

Gillette intensively studied Indian consumers with respect to their preferences for shaving items, and determined that, given distribution channels, product feature needs, and price points, a dramatically downscaled razor and blade were required.

As the article states,

"The price takes into account not only consumers but the kiosk owners who serve most shoppers in developing markets. The lower cost will encourage more small store owners to stock up on the item.

To cut costs, P&G eliminated the lubrication strip and colorful handle designs Indian men weren't willing to pay for."

It is stunning to me that a global consumer products company will actually shift from a blade price in the $2 range to one costing about a dime. Such scale of change in revenue at such low prices suggests how serious P&G is at moving its current 10% share of the Indian market up toward its global average 50% share. It's amazing that they plan to make money, to prosper, on 11-cent razor blades.

More interesting are these closing passages,

"P&G will introduce Gillette Guard first in emerging markets, says Mr. Carvalho, who doesn't rule out the possibility of bringing the cheaper razor to developed markets like the U.S. "We haven't yet looked in a detailed way if it makes sense doing this in developed markets," he says, "We'll probably know that in the next six to 12 months."

That could really make for interesting consumer reactions in the US, where, as the article also notes, recent advanced Gillette razors sell four for $16.99.