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Partial Equilibrium Analysis – Part 2
Andrew W. Sutton, MBA
In the first part of this series, we took at a look at Partial Equilibrium (PE) analysis in terms of analyzing a particular good or service rather than macroeconomic aggregates. What PE allows us to do as well is to both qualitatively and quantitatively assess the true effects of taxes and subsidies. We can also answer whether or not taxes and subsidies represent Pareto efficiencies. For our example we chose to look at the area of gasoline taxes. Many state governments are considering increasing gasoline taxes in the face of collapsing tax receipts. Intuitively, it would seem that such measures would be penny-wise and dollar foolish, but let’s use PE and see if that bears out conventional wisdom.
We’re going to also take it a step further and add an externality to our analysis: reserves depletion. Peak oil has been talked about in many forums, including military think tanks, World Bank whitepapers, and countless other places. We’ll take a look at efficiency and how it is affected by the lack of internalization by energy producers and consumers.
The first conclusion that we were able to arrive at last time is the fact that non-intervention (zero taxes / subsidies) market equilibrium are Pareto efficient, that is to say that Total Net Social Benefit (TNSB) is maximized. This fits the criteria for being Pareto efficient since any other combination would result in certain parties being made better off at the expense of other parties.
In the non-intervention equilibrium, there are only two types of surpluses – consumer and producer. There were no other parties involved. Certain economic agents produced the goods, while others consumed them. However, in the situation where there is a tax or subsidy (in this case a proposed tax), the government is now put into the mix and its impact on equilibrium must be studied. When the government collects a tax, it now has a surplus, which otherwise would have accrued to either producers or consumers. We’ll call the government’s new windfall GS.
The bottom line in any tax situation is that consumers are now short GS. In the most simplistic terms, GS could be returned to the consumers and a return to Pareto efficiency would be observed. Obviously GS has not disappeared; it is still available to society. This is where the rhetorical question of who spends your money better comes from.
In the following chart, note that equilibrium is present at Pm and Qm. When the government imposes a tax (let’s insert our proposed gasoline taxes in here), the price of gasoline is shifted to Pc, with producers collecting Pp. The new quantity produced/traded is Qd. This new reality reflects consumers’ lack of willingness to consume at the equilibrium quantity since they’re facing higher prices. It must be noted that elasticity of demand will determine exactly how much less they’re willing to consume, but for the purposes of this discussion, let’s assume that demand and supply are both linear functions.
In the situation where the tax is collected, consumers will lose surplus because they are paying more for what is consumed. Producers are losing surplus because they receive less for what they sell. The government generates a surplus because it collected the tax. Let’s take a look at the welfare calculations:
It is obvious from the welfare analysis that the equilibrium was economically efficient while the new tax equilibrium is not because the total welfare is lower under the tax equilibrium than the market equilibrium. Put another way, the change in total welfare from the new tax is negative, indicating that the tax is not economically efficient. –(E+F) is often referred to as a welfare loss in general economics classes.
Conversely, let’s think about the affect of reducing a tax. Let’s say we reduced the tax by 40%. We’d now see equilibrium re-appear at new price level P(reduced tax) and the new quantity at Q(reduced tax). The new –(E+F) or welfare loss would be considerably smaller than at the original tax level. In this case, the total welfare would have increased from the level of the original tax levy, but would still not be Pareto efficient since it would still be less than market equilibrium.
Partial Equilibrium with Externalities
Obviously with peak oil on the mind of most people, it pays to take a look at partial equilibrium with a negative externality, namely overproduction, in this instance. In our prior example, we had several classes of surpluses: consumer, producer, and government. Now, we’ll add a fourth economic agent, albeit a non-acting agent, in the form of petroleum reserves. It is important to note up front that we are not in any way trying to estimate the degradation of any specific resources, but merely to show how efficiency towards reserves will be affected by other intransigent policy.
In our example, we’ll label our variables CS, PS, GS, and ES for consumer surplus, producer surplus, government surplus, and externality surplus. The total welfare or TNSB will be the sum of these four surpluses. We can then further deduce that the change in TNSB (?TNSB) will be the sum of the changes of the four surpluses. ?G will merely be (R-S) revenue minus subsidy or spending. ?E will be the change of petroleum reserves.
In the above chart MSC represents the marginal social cost, and MPC represents the marginal private cost. The difference here between the MSC and MPC represents the ?ES or depletion of reserves in this case. The case where MSC intersects MSB is the efficient outcome from the standpoint of the depletion externality, and the intersection of MPC and MSB is the market equilibrium. It is fairly obvious in this case that consuming at the market equilibrium entails inefficiency in terms of reserves depletion. Again, any consumption is obviously going to diminish reserves, however, we’re searching for the most efficient mix of production and consumption.
Let’s take a look at total welfare and see what we get in terms of adding this very important externality to the equation.
In the case of petroleum, taxes can actually serve to bring MSC and MPC (MC) into line, meaning that in effect, taxes can make actual production equal the optimal from both a cost and depletion perspective. However, too high of a tax will obviously be inefficient as well. In our case, graphically, the tax would need to be precisely the difference between MSC and MPC (MC) in the above chart. This would serve to reduce production and consumption to the point where utilization was optimal.
Let’s look at the total welfare analysis:
Surpluses in the presence of the tax:
Surpluses at market equilibrium:
Welfare analysis (Sum of changes in all surpluses):
With the externality in place, less oil is produced, less damage is done to reserves, and TNSB is maximized with a tax equal to the different between MSC and MPC in place.
Summary and Conclusions
Consumers and producers both generally prefer the market equilibrium and, minus externalities, the market equilibrium is the most efficient as measure in Pareto terms. Taxes in such a situation will cause immediate dislocations and will not be efficient. However, in cases where there are externalities, taxes can be useful for bringing the monetary costs and the net social costs into line. We can easily conclude that imposing a gasoline tax merely for the purposes of increasing revenue is inefficient because the intent is not to bring monetary and social costs in line, but rather is arbitrary and capricious in nature. Further analysis could easily glean whether or not the actual taxes collected were efficient or not. The example of using depletion of petroleum reserves is key since taxes can actually help to make our use of this wasting asset more efficient. However, simply applying additional revenue-generating taxes on the purchase, consumption, or the byproducts of oil are not economically efficient, and while they may prolong reserves a bit further, there will be other economic costs that will be greater than the benefits accrued.
References: Primer on PE: R. Wigle, Microeconomics: J. Perloff, Economics and Public Policy: J. Kearl.
1 in 7 Americans Live in Poverty
Washington Post
In the second year of a brutal recession, the ranks of the American poor soared to their highest level in half a century and millions more are barely avoiding falling below the poverty line, the Census Bureau reported Thursday.
About 44 million Americans – one in seven – lived last year in homes in which the income was below the poverty level, which is about $22,000 for a family of four. That is the largest number of people since the census began tracking poverty 51 years ago.
The snapshot captured by the census for 2009, the first year of the Obama presidency, shows an America in the throes of economic upheaval.
Since 2007, the year before the recession kicked into gear, the country has almost 4 million fewer wage-earners. There are more children growing up poor. And for the first time since the government began tracking health insurance in 1987, the number of people who have health coverage declined, as people lost jobs with health benefits or employers stopped offering it.
With midterm elections less than two months away, the statistics bare the reality fueling much of the anger toward Washington.
In the Washington region, Virginia’s poverty rate rose the most, to 10.5 percent from 8.6 percent. Maryland’s edged up half a percentage point to 9 percent. The District’s rate was the highest, but it declined from 18 percent to 17 percent.
Although the recession’s impact was broad-based, there were disparities among groups. The official poverty rate increased for all races and ethnicities except Asians, who continued to have the highest median household income. More working-age adults lived in poverty, while the number of poor people 65 or older fell, largely as a result of increases in Social Security payments.
More than 51 million Americans lack health insurance, the census reported, and a greater-than-ever percentage of those who do have insurance are getting it from the government.
Scholars, nonprofit groups that work with the poor and President Obama all expressed concern about the gloomy picture.
Obama said the numbers could have been much worse were it not for government assistance.
“Because of the Recovery Act and many other programs providing tax relief and income support to a majority of working families – and especially those most in need – millions of Americans were kept out of poverty last year,” he said in a statement.
Many conservatives, however, laid the blame on government programs that don’t work.
“We’re spending more money fighting poverty than ever before, yet poverty is up,” said Michael D. Tanner, a senior fellow at the Cato Institute. “Clearly, we’re doing something wrong.”
Along with a rise in the number of people living in poverty, the census reported a decrease in the number of people who are living just above poverty level, suggesting that many of those just slightly above poverty slipped over the edge in the previous year.
Food banks and shelters around the country say they are seeing former donors asking for help.
Dale City resident Jamie Imler is one. She used to give money to charity and make quilts for homeless shelters. But since she began treatment for breast cancer last year, she has been too weak to work at either of the two jobs she held, one in a restaurant and one for a recruitment agency. Her income has dropped from $2,000 a month to less than $700 – not enough to cover her rent – and she has been coming for the past six months to a food pantry in Prince William County called Action Through Service.
“Things were good,” she said. “I was a single mom, raised my son and needed food stamps.”
“And now I’m here,” she added.
While the number of the country’s poorest people is higher than in any other recorded period, the rate is not without precedent. The last time it was this high was 1994. And in the early 1960s, it was over 20 percent.
Despite the jump in poverty, median income did not go down for those who still had jobs. Men working full time saw their median earnings rise 2 percent, to $47,000, while the median wage of women rose about the same amount, to a little over $36,000.
The median household income declined a little, to just under $50,000. But household income is down 4.2 percent since the recession began and 5 percent from its peak of more than $52,000 in 1999. Black households fared particularly poorly, as incomes dropped 4.4 percent compared with 1.6 percent for white households.
“We always have a situation where some population groups have higher poverty rates than others,” said Margaret Simms, who directs the Low Income Working Families Project at the Urban Institute. “During recessions, we see who bears the brunt in hard times in the kinds of numbers we see today.”
The statistics have quickly become fodder for a debate on the proper role of government in combating economic downturns.
“It’s a strong indication that there is not enough focus on growth and investment in job production,” said Ken Blackwell, the former Ohio state treasurer who is a fellow at the Family Research Council.
Ron Haskins, a head of the Brookings Center on Children and Families at the Brookings Institution, said government programs do not have enough money to make up for the decline among private and employer-provided health care. “Is the government going to pick it up?” he said. “That means bigger government, bigger expenses, more taxes.”
This summer, a proposal to extend jobless benefits to the long-term unemployed came under attack by Republicans, who objected to more spending that would add to the soaring deficit. The measure eventually passed.
Some of those who have struggled to find work are making their way to Good Shepherd Alliance, a food pantry in Loudoun County, which is one of the country’s wealthiest jurisdictions.
Vickie Koth, executive director, said she has grown accustomed to hearing clients say, almost as if dazed by their dizzying descent, that they used to volunteer at nonprofits like hers. The downturn will end some day, she noted, and hard times should be remembered.
“A lot of the community is really seeing this issue for the first time,” she said. “. . . Once this turns around, I hope that people will remember what we went through so that our communities will be more open to serving those around us who are in need.”
Staff writers Jennifer Buske and Caitlin Gibson contributed to this report.
Meet the New Goldilocks
Back in the glory days of 2008, the mainstream press, political pundits, and various government officials talked about the idea of the Goldilocks economy. Not too hot, not too cold, but just right. Of course the analogy ended when the bears chased Goldilocks out of the cottage. While the same outlets aren’t trotting out the fairy tale this time around, it is clear that the US has hit phase two of the Goldilocks economy and it is my guess that most folks will like this one even less than the first.
And again, there are three major bears that are threatening to once again drive Goldilocks deep into the forest.
Bear #1 – A Jobless Economy
Month after month, the Bureau of Labor Statistics releases Employment Situation reports that continue to befuddle even the most casual of observers. They have become Newspeak in the truest sense of the word. Take last Friday’s report for example.
BLS reported that 54,000 jobs had been lost in August. The media immediately jumped on the fact that private sector payrolls were up by 67,000 and immediately blamed the entirety of the negative report on the fact that it was only bad because some census workers got laid off. Talk about having your cake and eating it too. Back in the spring when the census workers were being hired, it was the same press that counted those temporary jobs as if they were actually created by a recovering economy.
But it actually goes a lot deeper than just the 67,000 jobs gained in the private sector. Let’s analyze:
331,000 people became underemployed for economic reasons, meaning that they desired full time work, but were only able to find part time work. 331,000 full-time jobs lost. That takes out total up to 385,000. Left completely uncounted are those folks who lost one full time jobs and managed to find another, but at a much lower wage.
BLS’ CESBD Birth/Death adjustment assumed that 115,000 full-time jobs were created by new businesses in August. This ‘adjustment’ has been a source of great consternation by labor market analysts and real economists for some time now. In what turned out to be a vain attempt at getting a look at the methodology used to derive this number, I contacted BLS and had email communications with no less than a half dozen staff economists in its Continuing Employment Statistics group. Not a single one of them could or would give me any information on how this metric was arrived at other than to point me to the website. At this point, we are left to assume that the Birth/Death adjustment is probably more arbitrary than anything based in reality. So for argument’s sake, let’s back out half of those fictitious jobs. Our total is now at 442,500 full-time jobs lost.
Finally, in order to keep pace with demographics, the economy needs to create 150,000 full-time jobs each month just to break even. Creating that many will not result in a reduction in unemployment but is the working equivalent of treading water.
Taking all this into account, August saw a deficit of 592,500 full-time jobs. And this was carried as a ‘good’ report? Former Labor Secy. Robert Reich actually came out and declared the report in its totality to be ‘awful’.
Keep in mind that the mediocre (at best) and lately awful jobs reports are after nearly a trillion dollars in direct stimulus and over another trillion in palliatives by the Fed in the form of purchasing mortgage-backed securities to stimulate the housing/construction sector. This reality alone should serve to underscore how dire the situation is. Unfortunately, this will likely be the status quo moving forward. Meet the new Goldilocks.
Bear #2 – An Unending Bear Market
It has been a cruel twist that the bear market which has been firmly in place since 2007 came precisely as the baby boomers began having serious thoughts about retirement. There have been countless stories of folks who retired in late 2007 or early 2008, either by choice or because they lost jobs and decided to retire, then had their portfolios halved over the next 18 months.
Sure the markets have recovered somewhat, but so many individual investors bailed out at Dow 8000 to 6500 and never got back in for the upswing. This market certainly has many folks perplexed. This is one of the reasons we have focused nearly exclusively on income producing investments, opting to lock in returns in the present rather than gambling on an uncertain future.
What many still have not realized is that the investing paradigm changed in a big way back in the year 2000. Stocks had seen an 18 year Supercycle of solid gains. One could quite literally pin the Sunday business section up on a wall, throw darts blindfolded and have a better than average chance of picking a winning portfolio. Precious metals languished for nearly two decades. That all changed in 2000 and as we entered a new century, we entered a new paradigm. Gold has surged fourfold and change and stocks have gone absolutely nowhere.
These Supercycles are generally 16, 18, or 20 years, so at a minimum, the current paradigm has another 6 years to go. Given all the distress in the economy from both a macro and fiscal perspective, it is entirely possible that we’re only halfway through this cycle. That means another 6-10 years of the stock market bear and another 6-10 years of strength in precious metals. At least in this case, there is a silver lining – pun intended.
Bear #3 – Leverage in All the Wrong Places
Perhaps the most ferocious of all the bears set to battle this new, unimproved Goldilocks is leverage or lack thereof. We have heard plenty about the leverage in the banking system and how it has been used to enhance bank and brokerage profits over the past few years. We’ve also talked plenty about how leverage has helped destroy the consumer, which is absolutely true. What is not being talked about, however, is the lack of leverage that we have as a nation in terms of righting the ship.
There have been many calls for the US to reassert itself as the premier manufacturing nation in the world. This would serve the dual purpose of diminishing our reliance on foreign goods as well as helping the unemployment situation by bringing jobs home. While I am a huge advocate of doing exactly this, there are several major problems that need to be dealt with along the way should we as a nation decide to pursue this path.
First and foremost is the fact that many American goods are not price competitive with their foreign counterparts simply because of the cost of labor. Placing tariffs on imported goods is an obvious solution proposed by many, but keep in mind the role that just the Chinese have played in keeping our economy afloat over the past decade in particular through vendor financing – the purchase of US debt.
Secondly, shifting manufacturing back to the US would require the rebuilding of the manufacturing infrastructure including the railroads and likely the power distribution grids in many areas as well. This is a huge capital investment and isn’t even on the radar of most policymakers. The mindset isn’t there at this time. For the most part we are content to convert old railways into biking paths instead of trying to figure out how to revive them.
A third area where the US lacks the leverage to reassert herself is in the area of energy. With peak oil on the immediate horizon, we are doing precious little other than burning a lot of corn to prepare for yet another paradigm shift. As long as we’re dependent on foreigners for one of the most important staples of economic growth, we will not be able to affect meaningful changes.
There are other areas as well, but I think the point has been made. A stagnant labor market, lack of individual wealth growth, and a lack of economic and tactical leverage to change key areas are conspiring to create this new Goldilocks economy which will plod along as long as trillions of new dollars are pumped in on a regular basis. Can anyone say unsustainable?
Next week we’ll finish up our analysis of proposed new gasoline taxes from a partial equilibrium perspective.
Gold Rises as the Euro Vaporizes
This wasn’t supposed to happen. When it was introduced 11 years ago, the Euro was to be the world’s newest, biggest, and best yet currency. There were strict guidelines for getting into Club Euro and you’d better follow them if you didn’t want to be voted off the island. What became immediately clear is that there were stronger members and weaker members. That fact is becoming increasingly apparent as the real state of the Eurozone now comes into clear focus. Over the years, rules were bent, concessions made, and explanations given, all for the purposes of justifying short-term benefits such as the availability of Italian milk to the Club. Yes, Italian milk.
In yet another example of the failure of globalization, or regionalization as it were, the Euro is poised on the precipice of disintegration. Ironically, it will not be the overprinting and resultant hyperinflationary spiral that kills the Euro, but dead weight in the form of various Eurozone welfare states. Germany and some of the other quasi-responsible members simply cannot carry their own burdens and those of Greece, Spain et al. The $1 Trillion rescue fund created in haste this past weekend was intended to inspire confidence in the dying behemoth. Instead, the sheer magnitude of the bailout has done the exact opposite. The Euro-Dollar pair has now sunk below pre-bailout levels and there is a good deal of doubt as to whether rescue recipients will be willing or able to hold up their end of the bargain. I pointed this out in last week’s piece. The temporary euphoria created by a trillion dollars of palliative paper is already gone. This is something that was alluded to in these pages years ago; the law of diminishing returns applies to stimulus and bailouts. As the periods of crisis occur in a more frequent fashion, the effectiveness of Keynesian monetary policy falls commensurately.
That aside, there are several other points that must be addressed as we examine the latest Tower of Babel in the global macroeconomic arena.
National Sovereignty Ceded
While anyone looking at the debt picture could tell that Greece (like so many others) was in trouble almost since its acceptance into the Eurozone, its problems burst into the international media in early 2010. One of the first things that many people noted was the major difference between the Greek government and that of America. Greece was hamstrung in that it did not have its own national bank; it relied on the ECB. While I am not a fan of national or central banks absent a strict Gold standard, this total absence of flexibility accelerated the Greek crisis in months, rather than years. Greece had given up its national identity to join the Club. And for a time it worked. The people of Greece enjoyed lavish social benefits and a carefree lifestyle. As an IMF official recently said, however, and I am paraphrasing: “The party is over”.
Other dominoes are set to fall as well since every other country in the Club has essentially the same problem: they cannot pay their bills, and have no way to wiggle out of it. While in the strictest of terms, this is not a bad thing; it outlines the categorical failure of international trading and currency blocs in the long run. There are always members of any cohort who will try to ride the coattails of someone else. It is human nature and it will not change. From that standpoint, the breakup of the Club was ordained from the day of its inception.
The mere existence of these multinational blocs also fosters a temporary sense of false security, as member nations don’t mind their own fiscal indiscretions because they have the perception that they’ll be picked up by the rest. And they usually are initially, so why change? This is precisely why the Greek people (and now the Spaniards too) are resorting to riots and national strikes. Old habits die hard.
At the bottom of the mess, however, is the loss of national identity. While we look at them as Greeks and Germans, they have in a way come to view themselves as Europeans – citizens of Europe. As Ben Franklin so eloquently put it, new nations come into the world like illegitimate children; half compromised, half improvised. In the case of the EU, we’ve already seen the compromise. Now the improvisation has begun in earnest.
Destruction from Within
Much in the same way the EU is being destroyed by the profligate spending and lackadaisical approach to fiscal matters of a few members, the United States is in a similar position of being devoured from within. This is where it gets very dicey, and I am bound to step on a lot of toes here, but it needs to be said. We know that roughly half of Americans pay nothing in the way of Federal income tax. While I don’t have exact numbers for the 50 states, I cannot imagine that the situation is much different there. This means that, like the EU, America has roughly half of its population riding the coattails of the other half. I am sure that in many cases there are good and noble reasons why this is the case, but I’m trying to address this from a structural macroeconomic standpoint rather than drilling down to specific reasons why people aren’t paying. Frankly, for the purposes of this discussion, it doesn’t even matter. In this way, America is a microcosm of the Eurozone. And we’re not alone. Great Britain is in the same boat. The bills cannot be paid. There is no way to squeeze enough money from the paying 50% to take care of their benefits let alone those of the other 50%.
Much like the EU, America has a central bank, which advocates Keynesian policies such as deficit spending and unfettered monetary creation. Save for one brief stint of interest rate austerity in the early 80’s, America has never wavered. And before we sing the praises of Mr. Volcker, we must consider that his actions most likely were taken to perpetuate the broken system as a whole as opposed to representing some blanket metamorphosis of economic thinking.
The single biggest difference here is that the members of the Club still have the ability to vote others off the island, and/or leave themselves. There is a point certain where the people of Germany, for example will no longer tolerate the abrogation of their economic and financial sovereignty and will either compel Ms. Merkel to take appropriate action or will replace her with someone who will. Hence all the talk of the breakup of the Eurozone. The die was cast on January 1, 1999 when the Euro officially became an international unit of account.
Race to Gold – the Endgame of Paper
All the gloom and doom aside, there is an out for those countries and individuals who fear the breakup of the Eurozone, dollar standard default, national bankruptcy, and the types of cataclysmic financial events that our behavior causes us to flirt with. It is shining right now, making new all-time highs as I pen this commentary. It is soaring even as the dollar races higher thanks almost entirely to the fall of the Euro. The mini liquidation last week in global markets was unable to shake it, so unlike the Lehman days in 2008. People around the globe are racing to Gold as the ultimate safe haven. Where the US Dollar is a proxy on the flaws of the Euro, so is Gold the ultimate proxy on the fallacy of stable paper currencies in a Keynesian world. Where paper currencies represent control, Gold represents freedom and a standard weight and measure.
This is probably one area where many here in America fail to understand the connection between our wallets and the first round of the Eurozone bailout. Thanks to our contributions to fund the IMF, and the resumption of various Fed emergency swap programs, the American taxpayer is on the hook for more of the European rescue fund than anyone who seeks to maintain their position in politics or finance is willing to admit. The burdens of lesser paper currencies are shifting to the already compromised US Dollar and the American taxpayer. There is nowhere else to turn except honest money. Truly, the buck will stop there.
One of the biggest ways our premium newsletter has benefitted its subscribers over the past few years is comprehensive analysis of the macroeconomic, monetary, and precious metals environments. In May’s issue, which will be released on 5/15, we cover the conventional wisdom surrounding sovereign debt loads, propose some alternate metrics, and look at the latest jobs figures. For more information, click here.
The Turmoil Continues
The obvious pick for a topic this week would be yesterday’s fearful plunge in US Markets. However, absent a well-defined culprit for the plunge (so far), it seems pointless to speculate on what really happened. I am still sifting through my own observations of that ten-minute span as well as those sent to me by subscribers. There are reports of index ETFs with near zero volume and unfilled orders at the market. Yesterday should also serve to remind us of the possible pitfalls associated with using stops. There were countless times in 2008 when stops weren’t filled. It happened again yesterday. Truly it was an awful day well before 2:40 with the Dow already off several hundred points. Looking at the bigger picture, yesterday was the fourth 90% down day in two weeks. The market’s disposition has clearly changed for the worse. All this aside, there are a couple of other topics that need to be discussed, which have an even larger bearing on what is going on behind the scenes.
The ‘Strong Dollar’ is Back?
For the past several weeks, the proclamations of a ‘strong dollar’ have been floating around the airwaves. Commentators will point at the rising USDollar Index and mistakenly assume that everyone wants our currency because our economy is recovering so nicely. What they fail to understand and/or convey is how the index is calculated. The index is nothing more than a weighting of the value of various currencies versus the Dollar. The Euro is currently 57.1% of the index and is in freefall thanks to out of control sovereign debt. Our policymakers should be taking notes on the developments in Europe. At any rate, since currencies are traded in pairs, when one half of the pair falls, the other rises. This recent surge in the US Dollar index, while good for us in terms of the cost of European imports has nothing to do with the strength of our currency. I’ve said this time and time again. We have to hope for bad things to happen to the rest of the world to keep the Dollar afloat. The true barometer of the strength of a currency is the cost of Gold in that currency. Even as the Dollar index has risen over the past several months, Gold priced in Dollars has risen right along with it. Gold is sniffing out exactly the points made above. People are fearful of paper currencies, and while they dump the Euro in favor of the Dollar in the short run, they are also loading up on Gold, the ultimate money.
The reality shown above is not a one or two day event, but a three month trend, which is intact even in a period of extreme market distress. Many people will try to draw parallels between 2008 and the present. By that logic, they argue that Gold should be falling since we’re flirting with another period of all-out liquidation. However, 2008 was largely a liquidity crisis whereas today we are facing that plus the bankruptcy of roughly 20 nations and the possible disintegration of at least one currency along with it. Yes, the sovereign debt crisis is that bad. Granted, the emerging divergence between the equity markets and Gold (shown below) is in its infancy, but it is a very important development and needs to be pointed out now.
Will Greece Pay Up?
On the front burner and driving the current hysteria is the situation in Greece. While the EU has come together to bailout the embattled nation, there are legitimate fears that:
a) The bailout isn’t big enough and is merely a band-aid. Apparently folks have been paying attention to the bailout of the US financial system.
b) The EU won’t be willing (or able) to extend the bailout
c) The people of Greece will not accept austerity measures
d) The people of Greece will dismiss their standing government in favor of one who will continue the current welfare state.
e) Greece will not pay back its neighbors for the bailout
I would contend that all of these are legitimate concerns. Several days of intense rioting and national strike by the people of Greece are making it very clear that at this point they have no intention of being under the thumb of austerity. This is what happens when you create a welfare state. Again, our policymakers should be taking notes. The country can’t pay back what it already owes, hence the ‘need’ for a bailout. How is a reasonable person to accept the notion that somehow Greece will now be able to pay back the money already owed plus another $146 billion in bailout loans?
Yanking the carpet out from under a welfare state is going to have monumentous social implications. The people of Greece are likely to dispatch their current government in favor of one who will take a disposition similar to that of Iceland and tell the lenders of the bailout money and the country’s creditors in general to take a real long walk off a short pier.
It would be bad enough if this problem stopped at the Greek borders, but unfortunately, it is nearly systemic in Europe, and in fact extends across the Atlantic as well.
Freddie Mac Continues to Bleed
In a harsh reminder of the perpetual state of bailout that the US has entered, Freddie Mac announced earlier this week that it will need another $10.6 Billion from the Treasury by the end of June to cover first quarter losses of $6.7 Billion. This wil run Freddie’s tab to well over $50 Billion with no end in sight.
Back in 2008, the USGovernment pledged to guarantee that both Freddie and Fannie Mae maintain a positive net worth. This has led to periodic infusions of cash into what is now admitted to be a black hole at both companies. What is most concerning about these actions is that there is little or nothing being done to end the reliance on bailouts. At the root of this problem lies the reality that people, for various reasons, cannot pay their mortgages. For many it is because of job losses. If we’re going to borrow and throw money down a black hole, it would have made a lot more sense to use the $50 Billion to build some factories that would employ workers who would produce goods made in the US. That would have put people to work and at the same time would have helped us ease our reliance on foreigners. Instead, we throw the money away, choosing to perpetuate a broken system.
April Jobs Report
As of this writing, the April jobs numbers are available. The economy ‘added’ 290,000 jobs in April, with generous upward revisions to both February and March. What is disconcerting about this report is the fact that we now know that roughly 600,000 new census workers are in place, yet these folks don’t appear to be attributed to the government’s portion of the non-farm payroll. BLS is claiming that of the 573,000 jobs created so far this year that 483,000 were created in the private sector. Yet looking at the Federal Government’s workforce over the past few months there hasn’t been much of an increase at all. So either government is trimming the sails in other areas or the census workers aren’t being counted as government employees, but are instead being credited to the private sector. A recent Gallup survey seems to bear out this discrepancy in that it concluded that government hiring was outpacing private sector job creation. While we don’t yet have the birth/death adjustment to April’s numbers, it is clear that something is amiss. The headline and U-6 unemployment rates rose to 9.9% and 17.1% respectively. State and Local government workforces continued to shrink in April, outlining the dire circumstances that continue to face many geographic areas.
With the cost of insurance on European bank bonds surging to a pre-Lehman high, it is apparent that at the very least, there is again a severe ripple in the credit system, this time at a sovereign level. Given debt levels around the globe it is quite likely that damage control will take precedent over containment.
Healthcare’s Double-Dip
One of the most interesting terms to come out of the past two years is the ‘double dip recession’. This is Newspeak for depression as far as I am concerned, but it fits with the new nomenclature we have used in an attempt to paint a crisis as not really being one. After all, what fun is it to admit that we’re in a morass that we have no hope of getting out of, or even a cogent, sensible plan for exiting? It is much easier to conjure up new terms in an attempt to move the boundaries into more palatable territory. This week, in the wake of the biggest nation-killing bill to pass out of the halls of Congress to date, I’m going to tell you exactly why we are now guaranteed a second dip (to use the nomenclature du jour), and how this is going to hit small businesses, which are the backbone of the real economy.
In order to accomplish this, I am going to cite exact passages from the House Bill from last summer (HR3200) and give you page references so you can download a copy of the bill and follow along if you so desire. I am using the older bill because it is much clearer in language than its Senate counterpart, and while not all of the provisions were passed in the exact same form, I believe this is where we’re ultimately going to end up. I am also doing this since many people simply cannot believe that our reps would put such provisions into legislation and will no doubt call me a liar and a shill. Before anyone gets any ideas about turning this into the sadly typical political muckraking that passes for debate these days, I want to refer you back to the articles I wrote in 2008 issuing scathing criticism of the banker bailout, the AIG bailout, Fannie/Freddie, and the housing relief bills, which were pushed by the ‘other’ folks in Congress. I couldn’t give a rip about politics. I am interested in the impact these bills will have on our economy and American families.
Piling on Debt
One of the planks that was used to promote this legislation was the fact that it will be a deficit-reducing measure. Let’s consider a few things here. The IRS will need to hire upwards of 16,000 agents and require an additional $10 Billion over the next decade (reported in the MSM) to ‘police’ the provisions of this new law. So the public sector will get even bigger. The late Milton Friedman did some fascinating research and modeling that pointed to the fact that every public sector job created destroys roughly 2 private sector jobs. That is 32,000 more private sector jobs down the tubes just on the IRS’ account using Friedman’s research, which has proven to be pretty accurate.
The bill itself is advertised to cost $940 Billion. Looking back a few years, we have Medicare Part D, which was advertised to cost around $500 billion. To date Medicare Part D has already added nearly $7 TRILLION in contingent unfunded liabilities to our national balance sheet. While it would be irresponsible to do a naked extrapolation here, the point is simple; this bill will, in all likelihood, end up costing an awful lot more than what has been advertised.
Martin Feldstein who, incidentally, concurs with the above assessment estimates debt service on the debt created by this new law to run around $300 billion over the next decade. In the new financial landscape where we talk in terms of trillions, a mere $300 billion doesn’t seem like a lot. However, when you consider that $300 Billion represents the total of yearly earnings of over 6.5 MILLION average US families, it is obvious we’re not talking about chump change here.
For a nation that already has liabilities that outstrip assets by anywhere between $15 and $20 Trillion dollars, it seems foolish to even consider more debt, but we don’t even blink twice anymore. Our government is probably already aware of the fact that the debt cannot be paid, so why not pile it on as long as others are willing to let the game continue? It’ll be ok until it isn’t, then we’ll have to think of something else. How’s that for an exit strategy?
The Provisions
Page 22 Section 113 – The Health Choices Commissioner along with the Dept. of Health/Human Svcs will conduct an audit of the books of any businesses that self-insure. This constitutes an additional regulatory burden on the small business that chooses the self-insurance route.
Page 50 Section 152 – This will allow illegal aliens to get health insurance; presumably at no cost since nowhere does it mention charging them or making them pay any sort of taxes, fees, or levies. The section reads that health care will be provided ‘without regard to personal characteristics extraneous to the provision of quality health care or related services.’ Although, ironically, Section 246 contains language that purports to exclude ‘undocumented aliens’ from Federal payments towards affordability tax credits. This is something of a joke since these people don’t file returns anyway and would not be able to take advantage of such a credit.
Page 149 Section 313 – Any employer who has a payroll greater than $401,000 and doesn’t offer a ‘public’ option for employees will pay an 8% tax on its payroll – payable to the Health Insurance Exchange Trust Fund.
Page 150 Section 313 – The following schedule applies to smaller employers who don’t offer a ‘public option for employees. The percentage represents the additional ‘tax’ they will need to pay to the Trust Fund:
Does not exceed $250,000 – 0 percent
Exceeds $250,000, but does not exceed $300,000 2 percent
Exceeds $300,000, but does not exceed $350,000 4 percent
Exceeds $350,000, but does not exceed $400,000 6 percent
Also of interest is the fact that Section 313 states that an employer hasn’t satisfied the contribution requirement if they simply cut the employee’s salary by the amount of the contribution. This is best illustrated with an example:
Let’s suppose Employer A has an Employee X who makes $10.00/hour and Employer A doesn’t offer a ‘public option’ for his employees. By law, the employer is now required to pay an 8% tax on payroll (let’s assume Employer A is in the highest bracket). If the Employer simply reduces Employee X’s wage by 8% to $9.20/hour, the Employer is in violation of the statute and is deemed to not have made a contribution. While on the surface this appears good since it forces the employer to effectively increase total employee compensation, this will be a job-killer. Employer A might very easily choose to reduce the workforce by 8% to keep costs the same.
It is pretty easy to see that just these four provisions add some serious burdens on what are considered to be small businesses. These are the business that employ somewhere in the neighborhood of 80% of all workers and create roughly 60% of new jobs. The most logical response of these businesses will be to cut staff or reduce non health-related benefits such as retirement contributions. Still mired in a severe recession, small businesses have not been able to grow top line revenues (nor have large ones to any meaningful extent for that matter) and are therefore going to be focused on controlling costs. This is precisely how the firms that have survived have done so over the past 2 years. This law will put many of them under. I wonder if BLS will take this new reality into account when it pulls CESBD (birth/death model) adjustments out of the black hat each month?
This says nothing of the encroachment on civil liberties such as the IRS having direct access to your bank accounts (Page 59 Section 1173A) and the creation of a National Heath Card ID and giving government instant access to your financial information (Page 58 Section 1173A).
All this and we still haven’t considered the overall impact this will have on the macroeconomy. We know that half a trillion dollars will be transferred from consumers to government vis a vis the ‘Shared Responsibility’ doctrine espoused in the law and it will likely be much more than that. That is an additional half trillion dollars that will not be spent efficiently by consumers, but will be squandered by government. Ok, I’ll admit it – I am deeply skeptical of any government ‘Trust’ Fund. For those who want to bicker on this point, I refer you to the status of the Social Security ‘Trust’ Fund as my basis for skepticism.
We also know that $500 Billion worth of Medicare cuts will be made, which essentially means that another half trillion will disappear from the pockets of households in pursuit of paying higher Medicare premiums. The beauty of the shift is that it is essentially GDP neutral since government spending counts in GDP at the same weight as consumer spending. In this new world of socialized everything we clearly need a new way of measuring economic output or at least differentiating legitimate output from the activities of our borrow and spend politicians.
With all the debt being accumulated, the money being pulled from the real economy in favor of the centrally planned utopia sought by so many on Capitol Hill, and the pressures brought to bear on businesses by this ‘reform’, it is hard to contemplate a set of circumstances under which we avoid another steep contraction in the real economy. It will be interesting to see how long it takes to go from recovery to contraction. My guess is about as long as it takes for a Baskin Robbins double dip to melt.
Corporations are People Too??
Thursday’s landmark Supreme Court decision has been called everything from proper to despicable and misguided. Clearly in the historical realm, every nation, empire, and circumstance of human organization has clear signposts that mark first progress, then the eventual destruction of the entity. That is not meant to be melodramatic; it is simply the natural progression of societies. If you don’t agree, ask the Greeks, Romans, and British. So where does Thursday’s decision fit into America’s progression?
Framing the Discussion
Once again it becomes necessary to properly define terms and concepts since failure to do so will almost certainly result in the forthcoming analysis being misconstrued.
The establishment of the corporation as an ‘artificial person’ by the Supreme Court in 1819 was used to give the corporation (an assembly of individuals of indeterminate size) certain rights that were normally reserved for individual people or ‘natural persons’. For example, a corporation can enter into contracts, file suit, and be sued. Corporations can even be charged with and convicted of criminal offenses, although generally, criminal charges often pass through the corporate veil to members of management as well. The corporation as it were cannot commit a crime of its own volition, but only by the action or inaction of someone entrusted with making decisions for it. One right that has not been conferred to corporations is the right to physically vote in political elections, however, corporations have been able to financially support political candidates for quite some time now.
Until the mid 1800’s, the government issued all corporate charters, and the applicant had to demonstrate that what they were doing or proposing to do would be in the public interest (a novel idea). How many corporations today do you think would fail this acid test? Even in the era of the public interest doctrine as we’ll call it, there were many folks including Andrew Carnegie and John D. Rockefeller who sought to skirt the public-interest doctrine by organizing as limited partnerships or Trusts.
The Issue
At issue for the Supreme Court to decide was a 20-year old ban on corporations and labor unions providing money for campaign advertising. The Supremes took it a step further and also struck down part of the McCain-Feingold campaign finance reform law that banned corporate and union-paid ads in the closing weeks of political campaigns. While on the surface, this looks like a victory for the First Amendment; I think it does little more than pave the way for corporations to buy even more politicians; and to do so under the protection of the law.
The entire issue comes down to the corporation as a person. Is the corporation entitled to all the same rights as a natural person? The very fact that the Supreme Court in 1819 designated corporations as artificial persons rather than natural ones indicates that they are not. Keep in mind that the spirit of corporate law is largely centered on limited liability, not enabling the corporation to wield disproportionate power in the political process (which arguably was already happening anyway). Take our largest corporations, with billions of dollars in quarterly profits. They are generally controlled by a Board of Directors and major shareholders; the number of which is comparable to those in attendance at a typical Little League baseball game. It is naïve to think that the American people can muster as much financial influence in Washington as even one large company, let alone all of them. The bottom line here is that a corporation is a creation of man and is not entitled to all of the same rights that are imbued in us by God. The framers of the Constitution, following along this line of reasoning, focused the founding documents on individual liberties rather than commercial ones.
Detractors of this line of thinking will accuse me of being hypocritical because on one hand I urge government to get out of the affairs of business, yet on this issue I encourage it to do the opposite. To reconcile these two disparate positions, one must understand the intended purpose of government. Our government was designed to protect the rights of the individual and to prevent people from running roughshod over each other. With that in mind, it would stand to reason that government shouldn’t be telling firms the maximum amount they can pay employees. It shouldn’t be bailing those companies out when they fail either. But it certainly should be preventing companies from stampeding the American people by making the electoral and legislative processes available to the highest bidder.
In conclusion, it is my opinion that what happened yesterday was misconstrued as being a First Amendment issue when it really is an issue of equal protection. Granted, groups like the NRA and other issue-specific groups have been shut out of certain political advertising in the days leading up to elections. That is wrong because those groups are speaking (hopefully) on behalf of their members as a cooperative. A corporation really can’t make that claim at the same level. The White House immediately issued a statement decrying the ruling, and although I agree in this instance, it must be pointed out that every single President in the corporate era has gotten money from corporations for their campaigns. That generalization can be extended to nearly every other political office in the country as well. The bottom line is that this activity was already going on anyway, but now the way has been paved for it to accelerate and increase in magnitude.
Yesterday’s ruling will allow corporations to dump unlimited funds into the coffers of political candidates and overtly buy the legislative process, using the government as a tool to enrich corporate bosses. It is easy to see why the power elite who controls the major corporations was most dissatisfied with the public interest doctrine in place in the 1800s. They greatly prefer that their companies be held to the doctrine of shareholder interest since any action that increases shareholder value is deemed appropriate and acceptable even if it encroaches on the rights of other citizens. Make no mistake about it; the government has already largely been purchased by the highest bidder. Yesterday’s decision legitimizes this previous illegitimate activity and gives the green light to a complete takeover of our government by large corporations.
I’d like to close with two quotations by Thomas Jefferson:
“Experience hath shewn, that even under the best forms of government those entrusted with power have, in time, and by slow operations, perverted it into tyranny.”
“I have the consolation of having added nothing to my private fortune during my public service, and of retiring with hands clean as they are empty.”
Uncle Sam Tops the Goods-Producing Sector
Yes, you read it right. I’ve been railing on this point for years now. We’ve needed to rebuild our crumbling manufacturing and goods-producing sector, yet it is Big Government who is doing all the hiring. So much so that there are now more people working for Big Government than there are in all goods-producing industries – COMBINED.
What does this mean? It means more reliance on foreigners for everything from food to fuel, to consumer trinkets. It means larger trade deficits (since you can’t export government – although it would really be nice to export the whole doggone thing right now!), and further pressure on the US Dollar.
Stimulus Nation
The result really wasn’t all that surprising. The reaction wasn’t either. On Thursday morning the Commerce Department released its advance GDP reading and proclaimed the end of the recession by asserting the American economy ‘grew’ at an annualized rate of 3.5% in the third quarter. A previous commentary already pointed out the fact that government borrowing shouldn’t be counted in GDP calculations anyway, so I’ll not repeat that exercise. Certainly there isn’t much to say on this topic that hasn’t already been said. However, there are some salient points that have been glossed over that are worth mentioning.
Cost vs. Price
It would probably be rather hard to find a single American that didn’t know the price tag of the stimulus bill. $787 billion has been included in nearly every news piece regarding the topic. What most people are not aware of, however, is that $787 billion only represents that amount of money actually put into the economy by the feds. It comes nowhere near addressing the actual cost of the program. A good recent example of this miracle of government accounting is the Medicare part D prescription benefit program. The price tag was $394 billion, but the cost is much higher – around $8.7 trillion and counting depending on which numbers you want to use. Granted this represents the net present value of the cost of these ongoing benefits over a 75-year period, but you get the idea.
Fortunately for taxpayers, the stimulus package is not an ongoing expenditure (yet), and as such consists of predefined outlays. Despite this, the total cost of the bill as compiled by the Congressional Budget Office is approximately $3.27 trillion. Amazing in this is the fact that we’ll pay nearly as much for debt service on the stimulus bill ($744 billion) as the measure was supposed to provide to the economy! Talk about sticker shock. The gory details are here.
The question now becomes one of return on investment. What exactly are we going to get for our $3.27 trillion? It had better be good too, because nearly all of it is borrowed from someone – either foreigners or the Fed. Unfortunately, such is not the case. Using the $3.27 trillion projected cost, the ROI for the stimulus bill stands at a whopping -415%. In the private sector, such a revelation would result in a project being killed instantly in the concept phase. Not so in the hallowed halls of Congress where the laws of economics and common sense do not apply.
A Good Deal for Taxpayers?
We have been assured in almost doublespeak fashion that the stimulus bill was necessary, and was in fact, a good deal for the American taxpayer and would create or save millions of jobs.
The ballyhooed cash for clunkers program deemed such a success ended up costing taxpayers around $24,000 for every car sold under the program. This when the actual benefit to the buyer was only $4,500. Some other examples, courtesy of AP, include:
- A company working with the Federal Communications Commission reported that stimulus money paid for 4,231 jobs, when about 1,000 were produced.
- A Georgia community college reported creating 280 jobs with recovery money, but none was created from stimulus spending.
- A Florida childcare center said its stimulus money saved 129 jobs but used the money on raises for existing employees.
One disconcerting admission in the past week came from Christine Romer, the head of the Council of Economic Advisors. She stated that the largest impact from the stimulus had already been felt and that moving forward, the stimulus would only serve to prevent the economy from slipping further rather than contributing to any growth. Sounds like a recovery eh? It would sound as if Ms. Romer is already laying the groundwork for the next brainchild of economic ignorance: Stimulus – The Sequel. Here are her quotes:
“By mid-2010,” she said, “fiscal stimulus will likely be contributing little to further growth.”
“While job losses will likely end early next year, robust job gains may still be several quarters away,”
“This is not a normal recovery, Coming out of this, we’ve got lots of things working against us.”
Like the laws of economics for starters?
What also must be noted is that the federal deficit alone for FY 2009, which doesn’t included net present value of unfunded liabilities, was $1.4 trillion. The fact that such a large sum of money had to be spent to prevent an all-out collapse of the US economy should be alarming to anyone with a pulse. The fact that current projections are for $1 trillion plus deficits annually for the next ten years should curl your eyebrows.
Let’s assume for a minute that Ms. Romer is correct and that we’ve seen all the bounce we’re going to get from the stimulus. According to AP, the number of jobs created directly by stimulus spending was around 25,000. Sure, there are probably some others that slipped through the cracks and it is very likely that some firms held off on layoffs because of the temporary burst of cash. But lets look at the cost of those jobs JUST in terms of the debt service created by the stimulus bill. Each of the 25,000 jobs created cost the taxpayer $29,600,000 in debt service alone.
Keep in mind that unemployment has been going up constantly during the time when we were getting the maximum ‘benefits’ from the stimulus. As soon as the money wears off, firms will fall back on their original plans, which include cutting back on staff. Another stimulus package will be needed – and soon – to stave off the infamous double dip that many economists and commentators have long been forecasting. The proverb that a house built on a rock will weather any storm, but one built on sand will certainly collapse rings very true in our current state of affairs.
The real question that needs to be posed to anyone supporting additional foolish stimulus needs to focus on an exit strategy. How will additional stimulus create a foundation for fundamental, healthy economic growth? The short answer is that it won’t, but lets make them answer anyway.