Friday, November 05, 2010

Holman Jenkins' Gets It Wrong Regarding Rick Wagoner As GM's True Savior

Holman Jenkins wrote a curious piece in last weekend's Wall Street journal insisting that Rick Wagoner has now been vindicated for his management of GM.

Contrary to the editorial's title, GM's Wagoner Gets His Due, I don't believe that's the case.

His column begins by referencing a New Yorker article in which Malcolm Gladwell evidently defended Wagoner as having saved GM. Jenkins wrote,

"Everything else you imagine constituting the GM turnaround was accomplished by Mr. Wagoner.

As Mr. Gladwell points out, he cut hourly labor costs and improved productivity until they were in line with Toyota's U. S. plants. He capped GM's health-care obligations by turning them over to the United Auto Workers (UAW) union along with a promised one-time payment.

He delivered GM to the point where its product quality and features were competitive with those of the best auto makers in the world, well before American buyers began figuring this out last year."

But he also wrote, just before that passage,

"What saved GM was the government's willingness to spend money saving the company that it would likely never get back, while allowing itself the privilege of using a bankruptcy court to ram through a restructuring that short-shrifted due process for GM's other claimants. Give anybody that kind of deal and they will appear (to themselves at least) a financial genius."

The last sentences is directed at Steve "Overhaul" Rattner, the car czar who took credit for what Jenkins and Gladwell believe was really Wagoner's rescue of GM.

With a GM IPO road show beginning imminently, I'm going to argue they are all wrong. GM isn't "fixed" yet. It's simply a partially-revived zombie on account of what Jenkins observed in that passage. Give any company tens of billions of free capital, stiff legitimate creditors in a kangaroo bankruptcy process, and it'll look better. It may even manage to creatively produce a book value per share that induces some people to consider buying the refloated equity.

But don't think for a moment that GM is "fixed," anymore than Chrysler was after Iaccoca's reign. Recall, if you will, that not so long after its 'rescue,' Chrysler fell into the lap of Daimler-Benz, only to be coughed back up as too problematic to retain. The rest is sadly recent history.

Why should GM be any different?

I maintain that Wagoner's efforts were slightly more useful than rearranging deck chairs on the Titanic. Jenkins is very kind in believing that Wagoner had righted GM, but that's simply not true, as his prior statement demonstrates. Further, both Jenkins and Gladwell evidently have conveniently forgotten Wagoner's many prior mistakes, including the Jerry York board mess and stiff-arming ideas of collaborating with Carlos Ghosn and Nissan. At the time, Wagoner was roundly, and rightly criticized for being so insular.

It took egregiously generous government aid, along with a bankruptcy, to 'rescue,' GM. Only after did it appear that Wagoner's prior moves would allow some modestly-profitable operation.

Let me put it another way. I contended, in prior posts, that bankruptcy would have cleansed GM of its financial baggage, allowing other companies to buy the good parts, or spin them back out on their own. Wagoner's successes, such as they were, only mattered to a post-bankruptcy GM. They were never sufficient, on their own, to save the firm.

As to Wagoner being the future 'go to' guy for a hypothetical President Paul Ryan? I don't think so. If Wagoner had any applicable skills to begin with, as Jenkins contends, they were largely a function of his being an accountant at GM for so many years. Government accounting makes GAAP look like a walk in the park, by comparison.

I seriously doubt Rick Wagoner's going to be of that much use to a future president. It's still not clear to me that he really accomplished all that much at GM as CEO, and he certainly didn't save it.

Thursday, November 04, 2010

Regarding Inflation- Contradictions & Naivete On CNBC This Morning

It's only 8:15AM, and already I've had a few laughs from Jack Welch's visit as a guest host on CNBC's morning program.

In commenting on yesterday's Fed purchase of $600B of Treasury notes, Welch was asked if such monetary easing was wise. Welch punted- big surprise- and said that he had supported Bernanke's crisis-era actions, and he wasn't about to second-guess the Fed chairman.

So much for CNBC's policy of bowing and scraping deferentially to anyone with a 'CEO' by his name, present or past, eh? I thought those guys were demi-gods, speaking received wisdom from some magical font to which they were granted access upon ascending to CEO-dom.

Then someone asked Welch if he thought this move was inflationary. In classic Neutron-Jack doublespeak, he claimed it wasn't, except that the large dollar creation will probably weaken the greenback, leading to commodity inflation, especially in oil and food.

How's that for a clear response?

After which, Carl Whathisname solemnly asked,

'And will we see those price increases coming through to us as consumers?'

Duh. Can you get much more stupid than to have to ask that question?

Then, to my horror, typically-savvy co-anchor Joe Kernen contributed to the lunacy by asking Chairman Jack, to paraphrase,

'So there's no wage inflation pressure. And cost-push is transitory, and won't really affect us, right?'

Wow. Jack's just abdicated his omniscient CEO mantle, claiming not to second guess the Fed, and Kernen asks him a nuanced question, the answer to which you couldn't get a panel of Nobel Economic Laureates to agree.

I guess this is where CNBC excels at providing entertainment, rather than solid insight and commentary.

This is only the trillion dollar question of the American condition. Last night, Glenn Beck was screaming about Wiemar-like inflation rates and George Soros speaking about the benefits of an 'orderly decline' in the value of the dollar. This morning's Wall Street Journal catalogued coming retail food price increases in the 7-13% range for staples like beef, milk and eggs.

Let's see- easy money, zero interest rates, QE2 on the horizon, and commodity prices jumping. Retail food price increases already in the pipeline.

Nope, no icebergs or inflation in sight, Captain. Full speed ahead!

It all brings to mind Rick Santelli poking fun at inflation measures which carefully exclude 'food and energy.' And, of course, Milton Friedman's quote, of which I am so enduringly fond,

"Inflation is always and everywhere a monetary phenomenon."

Money supply way up, velocity not down, and you've got inflation coming down the pike. Velocity may have fallen from 2008 until recently, but I don't think I've seen that it continues to decline. So that would mean new creation of money stock will necessarily inflate, further depreciating the dollar.

Skilling's Appeal On CNBC

CNBC's Tyler Mathisen did it again last week!

Ol' Ty managed to embarrass himself live and on camera in an interview with convicted former Enron CEO Jeffrey Skilling's attorney, Daniel Petrocelli. The interview took place after the Fifth Circuit's Appeals Court panel questioned Petrocelli regarding the Supreme Court's remanding to the 5th Circuit's Appeals Court to reconsider the Skilling verdicts.

To read more background on the issue, this source provides it, including this passage,

"In its ruling on the case, the Supreme Court said "honest services" prosecutions must involve bribery or kickbacks, and Skilling wasn't accused of those offenses.

The high court left it to the 5th Circuit to determine whether the error was harmful enough to require dismissal or retrial of any of Skilling's convictions."

In his interview of Petrocelli, Ol' Ty stumbled over his words and then erupted with a question to this effect,

'How does it feel to have basically gotten your client off on a technicality?'

Petrocelli was stunned by the question, taking a few seconds to compose himself. Then he dismissed Ty's question by stating they had fundamental differences in understanding the Supreme Court's ruling, so he wasn't even going to debate it. However, he noted, having the nation's highest court agree that the basis of the entire trial and jury instruction was flawed was not a "technicality."

I think it's fair to describe Petrocelli's tone as, first, incredulous, then, quickly, frosty.

I'd like to say Mathisen appeared chastened, but that didn't seem to be the case. I guess Ol' Ty didn't really even understand his mistake.

Now, I'm not a big fan of Skilling. But, if he was improperly tried, so be it. And if the Supreme Court ruled on that his trial was flawed, that sounds like significantly more than a technicality, as well.

Maybe next time they should assign a veteran court reporter to this sort of task.

The Fed's Balance Sheet & Leverage

The Wall Street Journal lead staff editorial yesterday detailed the rather horrifying nature of the current Fed balance sheet.

It's rather shocking to be informed that, with the 2008 financial crisis now past, the various short-term credit facilities with which the Fed took in short-term instruments in exchange for cash, have ended. Instead, the Fed owns, on current value, $1.1T in mortgage-backed securities and $154B in GSE debt.

The editorial notes that, while these securities provide a sort of phantom income of some $70B in fiscal 2010 which covers some of the budget deficit, they also pose a highly significant interest-rate risk to the Fed's balance sheet. Simply put, if and when rates inevitably move up, whether from tightening by the Fed, or selling of these securities, the remainder on the Fed's balance sheet will naturally decline in value.

Unlike US commercial banks, which are capitalized at about 8%, the Fed is now running at a 1.45% capital/assets ratio. Yet the assets are half-composed of highly risky fixed income instruments.

We are now actually in the position of potentially seeing our central bank have its assets decline in value to an extent that it wipes out the notional capital of the institution.

This surely must be the most perverse form of financial bubbles we have yet to see. The editorial points out that any added income booked in the past few years from the Fed's fantastically-bloated balance sheet is sure to be overwhelmed by asset-value losses in the years ahead, if things don't go perfectly when these private-sector fixed income instruments are unwound.

Scary, isn't it?

Wednesday, November 03, 2010

Meredith Whitney On Federal Bailouts of State Excesses

Meredith Whitney wrote a short but compelling piece in today's Wall Street Journal concerning federal bailouts of state-level excessive spending.

Specifically, she shone a spotlight on how several states, including California, Illinois and Nevada, have issued bonds whose interest expenses are subsidized by the federal government. Whitney went on to describe the modern U.S. state's finances, which now typically include an average of 33% of funding from the federal government. She also noted,

"New York, for example, spent in excess of 250% of its tax receipts over the last decade. The largest 15 states by GDP spent on average over 220% of their tax receipts."

Whitney repeats a concern many, including me, have expressed in the past, when she writes,

"How will taxpayers from fiscally conservative states like Texas or Nebraska feel about bailing out threadbare Illinois or California? Let's hope we never have to find out."

Considering New Jersey's current situation and political wrangling, and yesterday's election of another liberal Democratic governor in California, I think it's unlikely that we will not "find out" sooner than we would like.

In that vein, it's interesting that this column of Whitney's was both more sobering, yet also less worried than some of her prior warnings about state- and municipal-level defaults. This is an issue on which Whitney writes periodically and obviously follows closely. So it's puzzling that she only hints at consequences of this phenomena, rather than follows through with predictions for interest rates, debt, deficits, etc.

Viacom's Dauman On Its Strategy

Phillipe Dauman became Viacom CEO in September, 2006. Not long after, I wrote posts, here and here, about the company and Dauman. Here are two relevant passages from those posts,

"From the details of yesterday's Wall Street Journal article, it's not clear what to expect of Viacom going forward. The two cronies that Redstone has re-installed at Viacom, CEO Phillipe Dauman and COO-like Tom Dooley, have a track record of tripling Vicacom's stock price when they last worked with him at the firm. Put that way, it's not clear Freston ever really had a chance. So I wasn't surprised to read that he had been reluctant to take the Viacom CEO job in the first place last year.
Reading further, it sounds unconvincing that Dauman is going to simply "foster innovation within the company," and stress aggressiveness with its "multiplatform" strategy."
"Dauman, Redstone's returning lieutenant, has clearly shaken up the sluggish maneuvering between the two giants on this issue."

I didn't have high expectations for Dauman, and, frankly, from the nearby price chart of Viacom and the S&P500 Index. Judging by the position of the two curves in late 2006, it appears that the company has slightly outperformed the index, which has declined, by remaining flat.

A recent interview with Dauman in the Wall Street Journal provided some insight into his strategy for the firm. I must admit, I was surprised.

The article mentions Dauman's $1B deal to distribute Netflix content through a Viacom cable channel, and the consideration of returning Viacom's own content to Hulu. However, the piece also notes one pundit sensibly wondering why younger viewers would pay twice to see Netflix on television, when so many of them are more likely to subscribe directly via web-connected devices.

At least Dauman has successfully pulled Viacom out of the free YouTube environment, and concentrated on making money selling its content in larger chunks through other avenues of distribution.

Still, judging from the company's performance to date under Dauman, he'll need to do a lot more to make the firm a compelling investment alternative in the years ahead. If he doesn't, it may suggest what so many observers believe about the interplay of technology, old and new media, i.e., that old media has been permanently devalued in the current environment of new media and new online distribution outlets.

Tuesday, November 02, 2010

David Stockman On CNBC's Noon Program Today

David Faber's noontime CNBC program featured as its main guest former Reagan budget director David Stockman.

It's not hard to see why Faber's management wanted Stockman on today. I'm old enough to recall that the the one-time Reagan administration member went over the hill on his boss' tax cuts, publicly calling them misguided, and much worse.

He hasn't changed his tune in twenty-some years. Throughout the interview, Stockman swore that 'you can't cut your way to growth,' decried a Republican House as unable to grapple with the 'real issues,' and dismissed the electorate's concern over recent spending and legislation as 'yesterday's problems.'

Must be nice to be able to be so smug about problems yet to be solved. Stockman didn't present any empirical evidence for his personal views on taxes and spending.

Trouble is, Stockman was largely discredited by the economic boom brought about by Reagan's tax cuts and slowing of spending growth. That latter phenomenon wasn't an absolute 'spending cut,' but it was a substantial reduction in the rate of growth of spending on various entitlements and discretionary budget items.

I find it noteworthy that Faber didn't invite, instead of Stockman, now out of government for nearly three decades, someone like Mitch Daniels, a much more recent OMB director, and current governor of Indiana. Daniels wasn't even invited for a sort of pro-con debate with Stockman.

It goes to show how desperate CNBC was to find a figure with the correct, though aged, credentials, to mount his soapbox and spout the network's familiar politically liberal line.

Excusing Microsoft's Dismal Performance

Last week I watched a brief piece on CNBC discussing Microsoft's performance of the last ten years. Recently, I wrote this post which touched on the same topic. I wrote,

"The next chart shows the same two series for a much longer timeframe. In that chart, you can discern that Microsoft has actually lost value over the past decade. More so than the index."

In the CNBC discussion, two fund managers with opposing views were pitted against one another on the occasion of Bill Gates' birthday.

What amazed me is that, despite the admission of a decade of non-performance, the CNBC anchors refrained from criticism of the company. Instead, they seemed to want to favor the opinions of a fund manager who claims that the firm's cashflow will now rise, and the XBox proves the company is still innovative.

I can't think of many companies with a flat ten-year equity price performance that roughly apes the S&P which would enjoy this sort of media treatment.

But standards seem to be different either now, or in the case of Microsoft. In closing, the usual statistic of how much $1,000 invested in the Microsoft IPO would now be worth- it is, of course, several million dollars.

One of the anchors spoke approvingly that, regardless of the company's last decade, wasn't it great that Bill Gates is giving nearly all his money to charity.

Evidently, that makes the company's poor treatment of its shareholders acceptable.

Monday, November 01, 2010

Is A Gold Standard Really Better?

Last Thursday's Wall Street Journal contained an editorial by Charles W. Kadlee, Gold vs. the Fed: The Record Is Clear, contending that a gold standard are associated with better US economic performance. His piece begins with this paragraph,

"When it meets next week, the Federal Open Market Committee (FOMC) is widely expected to signal its desire to increase the rate of inflation by providing additional monetary stimulus. This policy is based on a false—and dangerous—premise: that manipulating the dollar's buying power will lead to higher employment and economic growth. But the experience of the past 40 years points to the opposite conclusion: that guaranteeing a stable value for the dollar by restoring dollar-gold convertibility would be the surest way for the Federal Reserve to achieve its dual mandate of maximum employment and price stability."

Regardless of accepting, at least initially, Kadlee's assertion about gold, he paints the Fed's obviously economically unlikely hopes starkly. Whether it was once true, in today's world of copious data and information, nobody really believes simple currency devaluation will fool global investors.

Kadlee then lays out the empirical bases of his argument in these following passages,

"From 1947 through 1967, the year before the U.S. began to weasel out of its commitment to dollar-gold convertibility, unemployment averaged only 4.7% and never rose above 7%. Real growth averaged 4% a year. Low unemployment and high growth coincided with low inflation. During the 21 years ending in 1967, consumer-price inflation averaged just 1.9% a year. Interest rates, too, were low and stable—the yield on triple-A corporate bonds averaged less than 4% and never rose above 6%.

What's happened since 1971, when President Nixon formally broke the link between the dollar and gold? Higher average unemployment, slower growth, greater instability and a decline in the economy's resilience. For the period 1971 through 2009, unemployment averaged 6.2%, a full 1.5 percentage points above the 1947-67 average, and real growth rates averaged less than 3%. We have since experienced the three worst recessions since the end of World War II, with the unemployment rate averaging 8.5% in 1975, 9.7% in 1982, and above 9.5% for the past 14 months. During these 39 years in which the Fed was free to manipulate the value of the dollar, the consumer-price index rose, on average, 4.4% a year. That means that a dollar today buys only about one-sixth of the consumer goods it purchased in 1971.

Interest rates, too, have been high and highly volatile, with the yield on triple-A corporate bonds averaging more than 8% and, until 2003, never falling below 6%. High and highly volatile interest rates are symptomatic of the monetary uncertainty that has reduced the economy's ability to recover from external shocks and led directly to one financial crisis after another. During these four decades of discretionary monetary policies, the world suffered no fewer than 10 major financial crises, beginning with the oil crisis of 1973 and culminating in the financial crisis of 2008-09, and now the sovereign debt crisis and potential currency war of 2010. There were no world-wide financial crises of similar magnitude between 1947 and 1971."

Interesting data, but I can't help wondering why Kadlee leaves a four year gap, 1967-71, not assigned to the gold standard years. Isn't that the period during which US stagflation began? I recall it as when the stock market crashed from the Nifty Fifty go-go years, LBJ levied the income surtax of 10%, and the US tried a 'guns AND butter' approach to economics. All while still on the gold standard. My guess is Kadlee's gold standard-era economic performances look much worse if measured all the way through 1971, when Nixon closed the gold window.

As Kadlee presents the post-gold standard data, he mentions an innocuous detail. His gold standard data cover 20 years, while the post-gold standard era comprises 39 years. So when he declares that we've had the three worst post-1930s recessions in the non-gold standard era, right away, one should note that the chances of more bad recessions since 1971 could be doubled anyway, as a null hypothesis, simply because of the length of the era.

Still, his point is seductive, is it not? Because, gold standard or not, what is co-extensive with going off the gold standard is floating exchange rates. And, in a sense, the Fed's unconstrained ability to print money without worrying about losing all its gold as cheap dollars show up to take advantage of the bargain that only 35 of them would buy- an ounce of the precious yellow metal.

Kadlee continues his case by turning to exchange rates,

"And what of the seductive promise that a floating dollar would make American labor more competitive and improve the nation's trade balance? In 1967, one dollar could buy the equivalent of approximately 2.4 euros (based on the pre-euro German mark) and 362 yen. Over the succeeding 42 years, the dollar has been devalued by 72% against the euro and 75% against the yen. Yet net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today."

Again, compelling. But also really the result of the post-gold standard floating exchange rates. And, once again, there's that troubling use of 1967, rather than, say, 1970, for the endpoint of the gold standard era. What difference would those 3-4 years have made? I don't know, and don't wish to engage in empirical research to find out. It simply bothers me when authors tailor time periods incorrectly for comparisons, and fail to disclose why.

There's no doubt, however, that the past 40 years of US deficit spending and dollar depreciation have eroded our purchasing power versus every other major currency. What is eye-opening for me, though, is his claim that  during the period, our net exports, which, in trade theory, should have boomed with the currency depreciation, have moved from surplus to large deficits of our GDP.

His summarizes his points thus,

"Economists and pundits may disagree on why the gold standard delivered such superior results compared to the recurrent crises, instability and overall inferior economic performance delivered by the current system. But the data are clear: A gold-based system delivers higher employment and more price stability. The time has come to begin the serious work of building a 21st-century gold standard for the benefit of American workers, investors and businesses."Again, Kadlee engages in some overstatement. Would we really say "a gold-based system delivers," or is it more correct to write, "a gold-based system is associated with,"

"higher employment and more price stability?"

And, as for "price stability," isn't that circular reasoning? Even a non-gold standard system of fixed exchange rates would have performed well. The problem, of course, is enforcement of such fixed rates in the absence of the natural punitive nature of the gold standard. That was the idea behind SDRs, but, with the abandonment of fixed rates, their replacement for gold in that role was obviated.

I think Kadlee's points are sensible and valid for an argument against floating rates, rather than for gold. Despite the troubling statistical legerdemain involving the missing 1967-71 data for comparisons, I'm quite willing to believe Kadlee's general thesis that some sort of enforced fixed exchange rate scheme would have constrained America's monetary profligacy over the last 39 years.

When I began studying economics in the mid-1970s, the warnings of excess American dollars and their inevitable effect on the US economy were already a decade old. But, back then, our trade deficits were still positive, as was our net foreign investment.

Nearly half a century of reckless deficits have reversed those two measures, and resulted in substantial loss of value in the dollar. You can't argue with that, gold standard or not.