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.

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?

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.

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.

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.

GM's Sweetheart Deal From Uncle Sam

I was watching CNBC yesterday afternoon when its automotive reporter, Phil Lebeau, appeared with a breathtaking, special update on the delay of GM's formal unveiling of its much-delayed Volt electric car.

After explaining that the delay is due to all of GM's senior executives being out on a road show to sell their imminent IPO, Lebeau let drop that the company will have repaid about $21B to the government, assuming a successful equity sale.

He then went on to note that the total amount of federal money pumped into the failed car maker is about $50B, but it's not realistic to expect all of that to be recouped.

Really, Phil? Wow, where can I get a deal like that?

Wait...I know....I should have bought a house I couldn't afford, not paid the mortgage, and gotten a mortgage modification!

Silly me.

It's the new culture of debt repudiation. Forget mere excess or conspicuous consumption. We're way beyond that now.

Consider how many other US companies have recently been given roughly $30B of capital, free of charge. No interest, no need to repay it. It's a gift.

Does anyone else think this is crazy and, ultimately seriously damaging to our economic system? Or am I alone in this belief?

On Global Central Economic Planning & Currency Management

University of Chicago finance professor John Cochrane wrote a rather scorching editorial this past Tuesday in the Wall Street Journal entitled Geithner's Global Central Planning. He begins with a simple, scathing assessment of the recent G-20 finance ministers' conference,

"Economists are full of bad ideas. Terrible ideas seem to emerge when the gurus get together to talk about coordinating their bad ideas. Last week's public letter from Treasury Secretary Tim Geithner to the G-20 finance ministers is a great example."

To begin to provide detail, he refers to language in a Geithner proposal emanating from the conference,

"Mr. Geithner starts with a dramatic proposal: "G-20 countries should commit to undertake policies consistent with reducing external imbalances below a specified share of GDP [later reported to be 4%] over the next few years." "

For some perspective as to ill-informed Geithner's idea is, Cochrane provides this classic example,




"Since when is every trade surplus or deficit an "external imbalance" in need of correction? It makes sense for a country that has good investment prospects to import a lot of goods, run trade deficits, and borrow money. Years later, the country puts the resulting products on boats to pay the lenders back. The U.S. borrowed abroad to finance our railroads in the 19th century and ran surpluses when Europe was rebuilding after World War II. Were these "imbalances"?"



Cochrane makes a very good point. How is it that Geithner is so skilled at judging what's an imbalance needing correction, versus a natural trade flow of capital and goods?

Then he considers the very real current situation of the US and China,

"Or consider a country (say, China) with a lot of middle-aged workers who need to save for retirement. It makes perfect sense for them to put stuff on boats and send it to a second country (say, the United States) whose people want to consume the goods. The people in the first country invest their earnings, say, by buying the bonds issued by the second country. And as they retire, they cash in the bonds and buy goods flowing the other way.



Do these and similar stories exactly account for current trade patterns? I don't know. But nobody else does, either. In particular, the army of economists in the basements of the International Monetary Fund (IMF) has no clue exactly how much each country should be saving, or where the best untapped global investment opportunities are around the world—including whether trade patterns are "normal" or "imbalanced." "

Just so. Cochrane continues by turning to Geithner's new idea,

"So what policies would Mr. Geithner have countries undertake to bring economies around the world into his idea of better balance? He says that G-20 "countries running persistent deficits"—that's the U.S.—"should boost national savings by adopting credible medium-term fiscal targets consistent with sustainable debt levels."



So Mr. Geithner knows that trade surpluses in the end come down to saving and investment. And he knows that in the U.S. people are trying to save right now. Our government is undoing their efforts with massive fiscal deficits. Mr. Geithner recognizes that most of the trade "imbalance" comes down to a big fat fiscal imbalance centered in Washington, D.C. But there's the catch. "Medium term" means "not now" and "not long-run entitlements." "Target" means "promises." Even if a target would make a difference, who believes in targets from our government? We don't know what the rate of taxation will be in three months!


Mr. Geithner goes on to say that "countries running persistent deficits" should "strengthen export performance," but he doesn't say how, or what other "performance" we should weaken to get it. Is this a code word for export subsidies, devaluation and industrial policy, and a plea that the rest of the world should let us get away with it?


His advice to the other G-20 countries, those "with persistent surpluses," is that they "should undertake structural, fiscal, and exchange rate policies to boost domestic sources of growth and support global demand." In particular, "G-20 emerging market countries with significantly undervalued currencies and adequate precautionary reserves''—have you figured out this means China?—"need to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals."


He argues for a brave new system, coordinated by the IMF, of international discretionary currency interventions: "G-20 advanced countries will work to ensure against excessive volatility and disorderly movements in exchange rates.""

You can see the problems already, can't you? None of this is reducible to practical, believable policies. And, even if it were, it's economic central planning on a grand, i.e., international scale. Anybody remember how that idea worked out for Russia during the last century?

Without a doubt the funniest passage in Cochrane's piece is also the most sobering in terms of the prospect of economic conflict between the US and China,

"What's the right policy toward China? They put a few trillion dollars worth of stuff on boats and sent it to us in exchange for U.S. government bonds. Those bonds lost a lot of value when the dollar fell relative to the euro and other currencies. Then they put more stuff on boats and took in ever more dubious debt in exchange. We're in the process of devaluing again. The Chinese government's accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort. The right policy is flowers and chocolates, or at least a polite thank-you note."

And we wonder why the Chinese are exploring more diversified baskets of assets into which to trade their depreciating US dollars?

Cochrane sums up Geithner's loopy idea with this concluding passage,



"This is all as fuzzy as it seems. Markets and exchange rates are not always right. But it is a pipe dream that busybodies at the IMF can find "imbalances," properly diagnose "overvalued" exchange rates, then "coordinate" structural, fiscal and exchange rate policies to "facilitate an orderly rebalancing of global demand," especially using "medium-term targets" rather than concrete actions. The German economics minister, Rainer Brüderle, called this "planned economy thinking." He was being generous. Planners have a clearer idea of what they are doing. "



The scary part for me is that this isn't some private economic white paper circulated among Geithner's staff. This crazy idea is out in public, proposed to the G-20, as if it's actually workable, or even desirable.

Ray Ozzie's Parting Shot At Microsoft

I haven't yet written about Ray Ozzie's departure from Microsoft. Somehow, I missed the October 19 article in the Wall Street Journal. However, I think it's a watershed event for Microsoft, and not a good one.


The end of the piece states something I think needs to be clear upfront,


"Mr. Ozzie is a legendary technologist in the computer industry, whom Mr. Gates once called "one of the top five programmers in the universe." "


I can't recall all of Ozzie's successes, and don't feel like Googling his bio right now. Suffice to say, he's legendary, and for good reason. Thus, his role as Chief Software Architect should have made a huge difference, in a good way, for Microsoft. Instead, here are added passages from the Journal article,
 
"According to one person familiar with the situation, Mr. Ozzie decided to quit Microsoft because "he has accomplished what he wanted to accomplish" at the company. His major contribution to Microsoft was in helping it shift the company to focus on cloud computing, in which more computing chores move into data centers rather than being executed on PCs operated by users.


But several current and former Microsoft executives say Mr. Ozzie failed to exert the kind of leadership many of them hoped for after he took over the title of chief software architect from Mr. Gates in 2008. These people noted that Mr. Ozzie did far less public speaking and other similar high-profile duties than Mr. Gates did, especially in his latter years at the company. Those kind of public ambassadorial duties have long played an important role at influencing employees within Microsoft itself, these people said.


Mr. Ozzie also clashed with other executives at the company, particularly Steven Sinofsky, now the president of Microsoft's Windows division, these people added. Mr. Ozzie appeared to lose a key battle with Mr. Sinofsky two years ago when control of Live Mesh, a data synchronization technology developed by Mr. Ozzie's team, shifted to the Windows organization at the company.


About a year ago, oversight of another initiative Mr. Ozzie was involved in, its Windows Azure cloud computing technology, moved to the server and tools business run by the division's president, Bob Muglia.


Mr. Ballmer in his email said that the role of chief software architect was "unique" at Microsoft and he won't fill the position after Mr. Ozzie's departure. A Microsoft spokeswoman declined to make Mr. Ozzie available for an interview or comment beyond the email."


Given Microsoft's lost decade of total return performance, as contrasted with Ozzie's accomplishments, I think one would tend to discount Microsoft's version and give Ozzie the benefit of the doubt for what went wrong at Microsoft.

It sounds believable that the internal squabbles at the firm derailed much of what Ozzie had hoped to do. One can only guess at what was lost by giving Live Mesh and Azure to company functionaries. After all, you have to recall that the crew that Ozzie found at Microsoft when he arrived in 2005 is responsible for the firm's total return performance since then. The first nearby chart shows that, when compared to the S&P500 Index, the technology giant comes up, at  best, about the same.

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.

So I wouldn't put a lot of blame for what didn't work on Ozzie. I suspect it's more like a software wizard being sucked into the large, slow-moving blob that has become Microsoft.

His warnings to the firm, as he left, sound on target to me. What I heard on CNBC the other day was that Ozzie predicted that millions of new future users will access the internet and software via cell phones and tablets, while Microsoft, clinging to PC and server operating systems, will lose out on controlling and profiting from that future growth.

Reviewing Ozzie's track record, versus Ballmer's, this isn't a very hard call to make in favor of the former.

Tyler Mathisen's Stupidity Is Showing On CNBC Today

Tyler Mathisen managed to demonstrate his incredibly stupidity and failure to grasp the difference between trading and investing this afternoon on CNBC.

It's about 1:40PM as I write this, and Ol' Ty just made a monkey out of himself.

Beginning an on-site report from a conference in Boston, he sputtered, to paraphrase,

'With all these sophisticated, fast trading algorithms, a staid old mutual fund doesn't stand a chance!'

For a guy who has ostensibly been reporting on financial markets for years, Ol' Ty really showed his lack of knowledge in that statement.

One thing which needs to be understood is that no matter how fast and complex the methods that trading desks use will become, they don't have appreciable effects on investments which are not fast-trading strategies.

It's not to say that buy-and-hold for years still works. But failure to buy an equity at the same price as some institutional trader, and paying a few cents more, won't matter much over months.

Of course, if you're Ol' Ty, and work for a network, CNBC, which insists on characterizing every investment decision with the nearly-trademarked phrase,

"So, what's the trade?!"

you wouldn't realize this.

It's bad enough that Ol' Ty can no longer distinguish between institutional trading and retail investing. It's worse when his ignorance and stupidity cause retail investors to misunderstand the markets and panic.

Good job, Ty. Looks like you've earned your money today.

Will Auto Makers Really Lead A Jobs Recovery?

I happened to catch my old friend, auto journalist Paul Ingrassia, on CNBC yesterday afternoon. He was debating, with several other pundits, including Bob Lutz, the role of Detroit's auto makers in sparking a US economic recovery.

From what I gathered, Paul was arguing that the best chance the economy has of creating jobs is for the three US-based auto makers to grow smartly in the years ahead. Essentially, he and the other guests, including, I think, an economist or two, some industry analyst, and the irrepressible Lutz, all agreed that we must pin our hopes for economic rescue on the auto sector.

What??????

Are these people crazy?

Autos are pretty much commodities. Sure, one or two models are special and command price premiums. But, generally speaking, as evidenced in China, entry into the auto sector is pretty easy. Auto makers are, in fact, auto designers and assemblers. It's not like River Rouge in 1920 anymore.

Plus, last time I looked, most economist bow to the Small Business God for job-creating growth. Ford, GM and Chrysler, wounded as they are, aren't small businesses. Except maybe in the 'small-minded' sense.

So how do you resolve this paradox? Three poorly-run large, old-industry companies, two of which should have died a few years ago, are going to magically lift America out of its recession? And magically create millions of jobs?

Sure, an uptick of auto sales gives these three companies their share. They hire a few people, and, indirectly, their orders for parts and materials spark hiring at their suppliers. I get it.

But that's nowhere near the number of jobs lost, plus population growth, since the official beginning of the recession in late 2007, is it?

Don't we usually hope and expect job growth from smaller, newer, more innovative firms than the erstwhile Big Three? Something more related to new applications of technology? Perhaps more in the vein of the next Google, Genentech, etc?

I respect Paul Ingrassia immensely for his knowledge of the inner workings of the auto industry. But I must confess, I missed the part where he became a respected macroeconomist by correctly explaining and predicting hiring in a large, complex economy as it exits a recession. And I guess I missed Bob Lutz having those credentials, too.

Joseph Stiglitz On Quantitative Easing 2

Nobel Laureate and Columbia University liberal economist Joseph Stiglitz wrote a fairly scathing editorial concerning QE2. He begins his piece thus,

"The Federal Reserve, having done so much to create the problems in which the economy is now mired, having mistakenly thought that even after the housing bubble burst the problems were contained, and having underestimated the severity of the problem, now wants to make a contribution to preventing the economy from sinking into a Japanese-style malaise. How? As Chairman Ben Bernanke announced last week, through large-scale purchases of U.S. Treasurys—called quantitative easing, or QE."

Stiglitz then lists three problems he sees with QE2:

"The problem is that, with interest rates already near zero, there is little the Fed can do to restart the economy—and doing the wrong thing can do considerable damage. In 2001, (then) record-low interest rates didn't reignite investment in plant and equipment. They did, however, replace the tech bubble with an even more dangerous housing bubble. We are now dealing with the legacy of that bubble, with excess capacity in real estate and excess leverage in households.

Yet even if the banks were willing and able to lend, lending to SMEs is typically collateral-based, and the value of the most common form of collateral, real estate, has fallen 30% to 40%. No wonder then that credit availability is so constrained. But QE in the form of buying U.S. Treasurys is not likely to affect this much. It will have some effect in lowering mortgage rates, and lower mortgage rates will put a little more money into people's pockets. Higher real-estate prices may also allow some SMEs to borrow more. But these effects, though positive, are likely to be small—so small as to make a barely perceptible difference in America's persistent unemployment.


There is another downside risk: QE may not even succeed in lowering interest rates, or lowering them very much. Given the magnitude of excess capacity, there is little risk of inflation today. But if the inflation hawks come to believe that the risk of future inflation is real, then they'll believe that short-term interest rates will rise. This will mean that long-term interest rates, even now, may actually rise, in spite of the massive Fed intervention, because long-term interest rates are based on expectations of future short-term interest rates.



QE poses a third risk: The bursting of the bond market bubble that the Fed is seeking to develop—the sequel to the tech and housing bubbles—will clearly have adverse effects on the economy, as we should have learned by now."


Stiglitz seems quite complete in his cataloging the problems with QE2 will do. It can't really ignite economic growth, due to the so-called liquidity trap. It won't help the small- and medium-sized US businesses (SMEs), which have more need than large firms for financing. And it may cause a bubble in one of the last unbubbled parts of the financial sector- fixed income. And, he notes, it continues the international currency devaluation competition which can easily hurt the US more than it helps us.

He concludes with a brief restatement of his argument,

"The upside of QE is limited. The money simply won't go to where it's needed, and the wealth effects are too small. The downside is a risk of global volatility, a currency war, and a global financial market that is increasingly fragmented and distorted. If the U.S. wins the battle of competitive devaluation, it may prove to be a pyrrhic victory, as our gains come at the expense of others—including those to whom we hope to export."

I think his last point is extremely valid and largely ignored by the US Treasury and the Fed. Yet it's the one which anyone with a sense of economic history knows contributed greatly to the US economic damage during the Great Depression.

We'd better hope Stiglitz is wrong, but I doubt he is.

Pawn Stars, American Pickers & Efficient Markets

Back in May of this year, I wrote a post concerning a popular History Channel program, Pawn Stars. I find the program to be a great exposition of business model implemented by owners who grasp the model and typically stick to it.

Expanding on the historical theme of vintage items, the History Channel added a program called American Pickers. The two stars of that program are Iowa-based friends of middle-age who drive across America seeking vintage collectibles which they 'pick,' to resell through their shop.

Whereas the pawn brokers are essentially deal-takers, due to the nature of their walk-in business, the pickers are deal-makers who typically offer a price, and certainly negotiate.

Having watched a fair number of episodes in both series, I've come to wonder how long the American Pickers can sustain their program and their business model. Here's why.

The pawn brokers have their customers freely offer goods, usually because they want money for the items, and either don't want to, or can't pursue a narrower, more specialized market segment in which to maximize the value of their wares. Time and again, people bring valuable, vintage firearms or curios, only to be talked into values which are half of what Rick and his crew allege they will get for the item, after it ties up their working capital for months.

Every time I hear that line, I think to myself, if it were me, I'd be heading over to a specialty dealer, if I hadn't done that in the first place. Whenever the weapons experts makes an appearance to authentic some rifle, pistol or knife, I wonder why the seller hadn't just gone to directly that expert's shop? Well, obviously, those who do aren't on Pawn Stars. But it's surprising to me how much money is probably left on the table by naive sellers.

Still, everybody understands that the pawn brokers want a 50% margin, although they might not understand the pawn shop's ultimate sale price, of which they may receive half, will be lower than more specialized buyers.

The American Pickers, however, seem to be playing a more dangerous game. They cajole and push old collectors into parting with items on a largely unsolicited basis. Sometimes they are invited to visit and buy items, but, typically, they are pressing themselves on people who've collected massive amounts of what most people would call junk, begging to buy some of the items.

Quite often, they will drive a good bargain, as illustrated by the end-of-show tallies of the prices they paid for various antiques, and what they believe to be the market price they can realize. Sometimes they have markups of as much as 200%!

Now, if you are a collector who's been visited by the American Pickers, won't you want to watch the program to see yourself? Then, won't you become a little irritated when you see the pickers post so many items with margins in excess of 50%?

How likely is it that the pickers from Iowa can make it through three seasons without either losing their sources, or watching their margins shrink below 50%?

Would you sit still for these guys to manhandle you over various vintage items after you saw them publicly exclaim how they bought something really valuable off of you at some embarrassingly low price?

I think Pawn Stars is pretty entertaining and, due to the nature of its customer base, has at least a few more seasons to run. Its History Channel derivative series, American Restoration, starring the guy who does most of their vintage vending machine and similar merchandise restoration, will also likely have a non-toxic effect on his own business model. That guy, again, has a willing, walk-in clientele eager to realize value.

But the efficient markets being openly created and publicised by the pickers strike me as likely to undermine their own business model, and soon.

One only has to look to the markets for financial instruments to see how a little pricing information, made public, tends to rapidly collapse margins, as well as spawn competitors. All of which tends to ruin what was once a quiet, dark, smaller but more lucrative market in whatever items now become so publicly priced.

BofA's Dismal Performance

Bank of America announced a $7.3B loss this week. By way of explanation of the gigantic lawsuit involving mortgage servicing, the firm's spokesman informed investors,

"We're not responsible for the poor performance of loans as a result of a bad economy."

True, but doesn't the bank pay a high-priced economist to forecast economic conditions? And shouldn't underwriting standards have allowed for less-than-rosy economic conditions for the next 30 years?

Of course, if the excuse is that the loan loss-related servicing issues came from purchased portfolios, well, that would suggest other management mistakes. But mistakes, none the less.

The huge loss apparently came from writing down credit-card business goodwill.

As is so often the case, the bank and, I assume, analysts will urge investors to view this as an 'exceptional' item.

Too bad that making questionable acquisitions wasn't all that exceptional for BofA a few years ago. One suspects they'll have a lot more 'exceptional' losses in years to come, thanks to Ken Lewis' misguided strategic moves.

The nearby price chart for BofA and the S&P500 Index shows how far the former has declined since late 2007. That was the last time that BofA's rate of return neared that of the S&P.

Now, it's down about 70% while the S&P has more or less flattened over the period.

Hardly the type of performance that makes investors cheer, is it? I suppose there are those that will believe it's the perfect time to bottom fish.

But with BofA and its checkered recent past, I would think that investment decision would come with substantial risk.

Henry Kaufman's Excellent WSJ Editorial

I haven't thought much of most of Henry Kaufman's Wall Street Journal editorials over the past few years. You can read my posts discussing them under the label 'Henry Kaufman.'

However, I like to believe that I criticize the thoughts, not the person. And Mr. Kaufman outdid himself yesterday with a superb piece entitled Bernanke's Inflation Target Misses the Mark.

He lists six reasons why Bernanke's recent speech indicating that the Fed will accept a 2% inflation target is a serious mistake. The more salient reasons are,

"Third, the Fed will use as an inflation target the core index for personal expenditure, excluding the cost of energy and food. The exclusion of food and energy from the inflationary indices dates back to the 1970s, when Arthur Burns was Fed chairman. Burns did this to minimize perception of the outbreak of inflation at that time.



Fourth, the chairman tries to support his recommendation by stating that "an inflation rate modestly above zero is shared by virtually all central banks around the world." That advocacy should hardly be considered a powerful endorsement, in view of the poor performance of many central banks abroad.



Fifth, through the use of inflation targeting, Mr. Bernanke believes that the Fed will have greater latitude, as he said last week in Boston, "to reduce the target federal-funds rate when needed to stimulate increased economic activity and employment." However, there is no evidence to suggest that under dire future economic circumstances the funds rate would not have to fall to near zero, where it is now.


Sixth, the Fed's inflation-targeting process is to be hinged to the Summary of Economic Projections, which the Fed now publishes four times a year. These projections span three years ahead and include projections for the rate of economic growth, unemployment and inflation. The chairman made no comment about the accuracy of these projections since their initiation three years ago. The fact is that they have been off the mark."

I find the third and sixth reasons particularly, shall I say, "on target," pun intended? This idea of exempting the major sources of inflation in an inflation index is preposterous. One which CNBC on-air staffer Rick Santelli, as well, routinely criticizes. Then Kaufman sensibly notes that the Fed's own projections are not all that accurate. Not comforting at all, is it, for anyone who lived through the great inflationary period from LBJ to just after Paul Volcker began to wring inflation from the US economy?

Along those lines, Mr. Kaufman next asks reasonable questions. Things seldom turn out perfectly. What about imperfect, vexing combinations of inflation and unemployment,



"Now that an inflationary bias will be introduced in monetary policy, market and economic uncertainty will heighten. How long will the Fed allow inflation to breach the 2% level before it pulls back on the monetary reins? Will the breach be allowed for one or two quarters or longer? Suppose the unemployment rate falls to 8.5% but the inflation rate reaches 3%. What then?

Do we trust Helicopter Ben & Co. to manage such situations better than our prior, not-Paul-Volcker Fed Governors?

Kaufman lastly turns to what I think is the curiously missing but incredibly fundamental, important fact in all of the Fed's misguided inflation targeting speak- the debauching of the value of the dollar.


"More importantly, if a 2% annual increase in inflation becomes an acceptable target, Americans will be forced to accept a substantial depreciation in the purchasing power of their currency. A 2% annual depreciation equals a compounded loss of 22% over 10 years, and the loss would total 34% if the inflation rate averages 3% annually. That's a target we can afford to miss."



Pretty stunning figure, isn't it, that 22% purchasing power decline in a decade? The mathematics of compounding get scary at surprisingly low rates.

Consider what global investors must be contemplating as they read Mr. Kaufman's editorial. How comfortable are the Chinese at watching the value of their large dollar-denominated holdings being announced to decline in value by nearly a quarter in the next decade- if they are lucky?

Banks Begin To Exhibit Consequences of New Regulations

Yesterday I wrote this post concerning David Malpass' recent insightful Wall Street Journal editorial, and his subsequent defense of it, if that's the right word to describe the one-sided conversation Malpass had on CNBC that day with the network's faux-economic reporter Steve Liesman.

My mind had more or less blocked out the details of that discussion, until I read two articles in yesterday's Journal concerning bank earnings and capital requirements.

The two articles concerned Goldman's recent earnings, which were down 40% from last year. It's not a big secret what happened. In the anticipation of the eventually-passed Congressional financial regulation bill, the firm trimmed its proprietary trading activities and began to keep capital more liquid, earning less, in reaction to the looming regulatory and capital requirement uncertainties.

Right underneath that article on page C3 in yesterday's Journal was one entitled Banks Confront Weight of Risk. That piece discussed the consequences of the new Basel III bank capital rules. In Goldman's case, the firm's CFO explained that regulatory capital would need to rise from $451B to $750B. Elsewhere in the article, it was explained that the new Basel rules increase capital ratios on risky assets, while simultaneously reducing the types of liabilities which are allowed to count as capital. One example of the first effect was an estimate that "Morgan Stanley's risk-weighted assets will jump 80% under the new Basel rules."

Any way you look at it, Basel III alone will begin to rein in decades of profligate, risky banking behavior by many firms which either were, or became, federally-backed institutions.

This isn't a bad thing, in my opinion. As I've contended in earlier posts, banking, in its totality, should never have become a growth industry. Sure, individual businesses, such as mortgage lending, consumer finance, or various structured instruments, might grow at elevated rates for short periods of time. But overall, banking is an economically derivative sector. It can't, in total, over time, grow faster than the economy it serves, without essentially taking more risks.

Again, as I've written in prior posts, there are and, now, will certainly be cases in which bank managers can't profitably deploy all the risk capital assigned to their positions, when capital costs are included in those profits. In short, properly risk-adjusted returns will fall, capital will shrink, and aggregate bank total returns will probably become appropriately more sluggish.

If anything, this regulatory change will push more risky finance business into the privately-held sector. Which, if you think about it, is a regulatory response to the decades-long trend of investment and commercial banks taking excessive risks while selling the ownership of such risk to the public. Looks like riskier financial business is headed back to private partnerships, as it was prior to the 1970s.

What does this have to do with David Malpass and yesterday's post?

Well, as my memory of his comments recovered, I recall his arguing that it isn't high interest rates that is holding back US economic recovery, but, rather, uncertainty on many fronts- regulatory, legislative, fiscal and monetary policy. In response, the economically unschooled Liesman repeated various platitudes about 'no double dip,' gradual recovery, etc., etc., etc.

Goldman's explicit statements about reining in activity in anticipation of greater regulatory burdens, the exact nature of which is as yet uncertain, supports Malpass' positions. Especially as they accompany such a precipitous fall in net income.

How's that for empirical evidence of an economist's contentions?

The Spreading Mortgage Foreclosure Mess

Things has certainly gotten out of hand in the mortgage foreclosure processing mess, haven't they?

With the NY Fed weighing in on a lawsuit against BofA, things have escalated to an unprecedented level.

Yet, at root, it continues to appear to be much ado about nothing. A tempest in a proverbial teapot.

According to a Wall Street Journal editorial which ran yesterday, the number of inappropriate foreclosures they could find numbered no more than dozen, in a nation of over 300 million people.

So the bottom line is that almost nobody who has not been delinquent on their mortgage is being foreclosed.

Meanwhile, I listened to a Fox News report yesterday which included an interview with the owner of a home with a modified mortgage. I won't get the numbers exactly right, but the woman's mortgage declined from about $1,800/month to something in the neighborhood of $700/month after modification.

Talk about injustice! This is why so many people resent those who made unwise home purchases, then receive generous modifications which leave them in homes they can't actually afford. Rather than putting those homes on the market at the market-clearing, lower prices which others could afford.

To me, the allegations of robo-signed foreclosures is a red herring. The real issue remains that politicians have been improperly leaning on and coercing banks to suspend legitimate foreclosures since the presidential primaries of 2008.